'If 50% tariffs continue, near-term adverse impact on growth very likely'

Saugata Bhattacharya, member of the Reserve Bank of India’s (RBI’s) Monetary Policy Committee (MPC) says the earlier RBI research estimate of 1.4–1.9 per cent real neutral rate is probably outdated. Updated estimates of potential growth, inflation and other analytic metrics are needed to assess the appropriate terminal rate, he said during a telephonic interview with Manojit Saha. Edited excerpts: 

You have noted that the reduction in deposit was more than the loan rate, and that is a matter of concern. What is the reason for your concern? 

At the outset, I give my usual disclaimer. Comments are my opinion, not of the MPC. Public data on transmission into lending and deposit cuts is at end-June. The magnitudes might have changed since then. The trade-off between borrowers’ and depositors’ behaviour based on their respective interest rates warrants careful analysis. The importance of domestic savings is likely to increase, given the uncertainties on our external balance. Bank deposit growth had been slowing for some time, but might begin to pick up following the infusion of liquidity. Of equal importance is to monitor the composition of deposits, retail and wholesale, which tend to behave differently. 

You have also said that the sources of moderation in recent inflation prints originate from a concentrated subset of the index, which is a latent risk. Why do you think so? 

Vegetables and pulses have been the main contributors to the disinflation in food prices; hence the drivers are concentrated. We have seen multiple vegetable-led food inflation cycles since 2014. Charts of food inflation appear to show increased volatility in recent years. With climate-related events on the rise, food prices are vulnerable to weather shocks. The lower vegetable prices might also adversely affect cropping decisions, initiating a “cobweb” effect. 

Given the tariff-related shocks, do you think growth projection for FY26 can be revised downwards? 

In this environment of continuing elevated uncertainty, particularly for India relative to our trade competitor peers, the best we can do is analyse different scenarios. We can assess their outcome probabilities and the likely effects on economic parameters. The statistical confidence bands of the fan charts of the forecasts will provide a better sense of the potential variability of outcomes. However, if the India-specific tariffs continue at the indicated levels of 50 per cent, without taking into account the effects of counterbalancing policy actions, an adverse impact on near-term growth is very likely. 

What will open up space for policy easing, lower growth than projection, or lower inflation than projection? 

An MPC colleague had earlier succinctly stated that the drivers of policy response, in respect of the growth–inflation balance, depended on which of the two was farthest from the target and the presumptive time it would take to reach the target. That’s the approach which will guide my decisions. 

Do you agree that there is only limited space for further easing as inflation is projected above the 4 per cent target from Q4? 

The extent of space for further policy easing will depend upon the evolution of inflation and growth, within the framework of the macro-financial environment defined by the nature of open economy macroeconomics. There is little scope for forward guidance on this. The direct, secondary and tertiary impacts of various economic and policy unknowns will need to be understood. 

Where do you see the terminal rate in this rate cut cycle? 

The terminal rate, or real natural rate, is technically the interest rate at which savings and investment balance. Both these quantities remain very uncertain at this point. Earlier, RBI research had estimated the real natural (90-day T-bill) rate at 1.4-1.9 per cent, which in a steady state translates to a repo rate of around the present 5.5 per cent. However, this estimate is likely to be outdated, with changed economic conditions. Updated estimates of potential output growth, the shape of the output–inflation trade off (a proxy of the Phillips Curve) and other analytic metrics are now needed to assess the appropriate terminal rate.