Complex picture: MPC should avoid policy adventurism in uncertain times

The decline in the consumer price index-based inflation rate for December is unlikely to bring much relief to India’s economic managers, given the growing policy complications in recent months. The data released on Monday showed that the inflation rate declined to a four-month low of 5.22 per cent, compared to 5.48 per cent in November. Even as a standalone number, the decline is not comforting enough to conclude that the Reserve Bank of India’s Monetary Policy Committee (MPC) will be in a position to start reducing the policy interest rate in the February meeting. A lot will depend on the projection for next year. According to the latest projections, the MPC expects the inflation rate to average 4.6 per cent in the first quarter of next financial year, declining to 4 per cent in the second quarter.

 

Given the fact that higher food prices are largely driving inflation outcomes, the risks to projections are high. However, other economic stakeholders may not be willing to give much time to the MPC and RBI to watch the actual inflation outcomes over the next few months. The rate of growth in gross domestic product slowed to 5.4 cent in the second quarter this financial year. The first advance estimate of the statistics department showed that the economy would expand by 6.4 per cent in 2024-25, the lowest growth rate since the contraction of the pandemic year (2020-21). The Indian economy expanded by 8.2 per cent in 2023-24. Therefore, it is being argued that the policy interest rate must be lowered to support growth. However, again, the policy choice will not be this straightforward. The rupee is under pressure and will have implications for inflation and growth outcomes.

 

Despite the active intervention of the central bank, the rupee has fallen over 1 per cent thus far in 2025 against the US dollar. However, the immediate underlying reason is not particularly India-specific. Nonetheless, since India runs a current account deficit and needs savings from the rest of the world to bridge the gap, large capital outflows can complicate things. What is happening in recent months is foreign money is moving out because of changed expectations in the United States (US). The US Federal Reserve is now expected to go slow on rate cuts. The outlook may change further, depending on the timing and extent of the incoming Donald Trump administration’s policy changes. Mr Trump has promised to increase tariffs on US imports, for example. If implemented, it would push up the inflation rate in the US and change the monetary policy choices. In such conditions, more money will flow to the US because of higher bond yields. Consequently, currencies like the rupee will be under pressure.

 

Although the rupee is overvalued in real terms and needs to depreciate to protect India’s external competitiveness, the nominal decline will make imports expensive and affect inflation outcomes. The inflation projection of the MPC will ne­ed to factor in such possibilities, which will not be easy, given the level of uncertainty. A policy rate cut at this stage, theoretically, will further reduce the yield difference between Indian and US bonds and make Indian debt unattractive for foreign investors. Further complicating the picture, new sanctions on Russia have pushed up global crude oil prices, which will affect inflation outcomes to the extent it is passed on. Thus, overall policy complications have increased significantly. Since the global environment is extremely uncertain, it would be advisable for the government to focus on growth without undermining fiscal goals. The RBI, meanwhile, should remain focused on price and financial stability. This is not the time for policy adventurism.