Staying the course

Mr Das has set the record straight

The 50th Monetary Policy Committee (MPC) meeting of the Reserve Bank of India (RBI), which ended on Thursday, was widely expected to be a non-event. In line with market expectations, the committee decided to leave the policy rate and stance unchanged. Consequently, the policy repo rate remains at 6.5 per cent. The MPC also decided to retain the growth and inflation projections. It expects the Indian economy to expand 7.2 per cent this financial year. The growth rate in the first quarter of next financial year is expected to be the same — 7.2 per cent. On inflation, the committee expects the headline inflation rate to average 4.5 per cent this financial year. The rate is projected to be 4.4 per cent in the first quarter of 2025-26.

Although the broad monetary policy announcements were on expected lines, the high point of the day was the decision of RBI Governor Shaktikanta Das to underline the fundamentals of inflation targeting, monetary-policy operations, and financial stability. The latest Economic Survey suggested: “India’s inflation targeting framework should consider targeting inflation, excluding food.” The primary reason was that food inflation is often not demand-induced but is a result of supply shocks, and short-run policy tools are more appropriate to address price pressures emanating from excess aggregate demand growth. As also argued by this newspaper earlier this week, ignoring food inflation is not advisable. Mr Das did well to set the record straight. It should help address all doubts. Some of the broad points are worth emphasising here.

The legally binding target of the RBI is the headline consumer price index-based inflation rate. Food has a weighting of about 46 per cent in the index and, thus, cannot be ignored. The consumer understands inflation in terms of food prices rather than other components. Notably, the food inflation rate contributed more than 75 per cent to the headline inflation rate in May and June. Further, it affects household inflation expectations, which have implications for the future trajectory of inflation outcomes. In fact, household inflation expectations have edged up in recent months. Persisting high food inflation can affect expectations and spill over to the core rate. A behavioural shift among households can make overall inflation outcomes sticky with higher economic costs. The MPC can always look through transitory increases in food prices. However, a more persistent increase cannot be ignored.

In the context of financial and banking stability, the governor noted for retail investors, alternative avenues were becoming more attractive, and banks were facing challenges in mobilising deposits, which were trailing loan growth. Consequently, banks are raising funds from other sources, which can potentially lead to structural liquidity issues. It was also highlighted that certain segments of personal loans continued to grow at a rapid pace despite last year’s presumptive regulatory action. While there is no imminent risk to financial or banking stability, and the Indian banking system is well capitalised, some of these observations can be seen as an indication for the system to address potential risks in time. The RBI also did well not to overreact to the recent global financial-market turmoil. Given the strong position on the external front and with economic growth momentum expected to continue, the MPC rightly decided to stay the course and focus on inflation management.