Beyond the status quo

Indian economy is in a comfortable position

The six-member Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) is meeting for the first time in 2024-25 this week against a favourable economic backdrop. The data released on Monday showed goods and services tax (GST) collection in March, net of refunds, increased 18.4 per cent year-on-year. The year ended with an increase of 13.4 per cent in GST collection. Given the latest available numbers on overall tax collection, the government should be able to meet the revised fiscal-deficit target of 5.8 per cent of gross domestic product (GDP) in 2023-24. The fact that the government has reiterated its commitment to adhering to the medium-term fiscal glide path should provide comfort to the RBI. More broadly, the government now expects GDP growth to top 8 per cent in the March quarter, which will take full-year growth for 2023-24 above 8 per cent.

The position on the inflation side is also improving. While the headline retail inflation rate is still running marginally above 5 per cent, the core rate is well below the 4 per cent target, which should give enormous comfort to the central bank. The MPC, according to its last projections, expects the headline inflation rate to average 4.5 per cent this financial year. While the core inflation rate is below 4 per cent, it is the food basket that is essentially keeping the headline rate above target. The food inflation rate in February was 8.66 per cent. Notably, it is on the higher side despite active intervention by the government. The Union government has imposed restrictions on exports and stock limits for several food items. The government last week, for instance, asked traders, food processors, and major retailers to declare their stock holdings of wheat every Friday because the stock-holding limit expired on March 31. Restrictions on trade and stock holdings may help contain inflation in the short run, but this approach can affect production and availability in the long run.

Nonetheless, if the inflation rate indeed moves as projected by the MPC and averages 4.5 per cent this financial year, the real policy repo rate would be 2 per cent, which can be considered high and potentially undermine growth outcomes. As one of the MPC members, Jayanth R Varma, noted in the last meeting: “A real interest rate of 2 per cent creates the very real risk of turning growth pessimism into a self-fulfilling prophecy.” So, should the MPC consider reducing the policy rate at this stage? As most market participants anticipate, maintaining the status quo at this stage will be sensible for at least three strong reasons. First, the country is in the middle of a general election and it makes sense to wait at this stage. Second, while the core inflation rate is in the comfort zone, the headline rate, driven mainly by food prices, is still considerably above target and can impart volatility. Thus, any possibility of a policy rate cut should be considered only with clarity on monsoons. Third, while the US Federal Reserve has indicated that it is on course to cut the policy rate this year, it’s worth watching how expectations shape up in the coming months. This is crucial from the perspective of external stability, which has been a notable strength in recent periods. Overall, since growth is not a concern at the moment, the MPC can afford to wait and let the disinflation process be completed.