Monetary policy: Surely, a rate cut could’ve waited for some clarity to emerge

In December, the MPC opted to play safe. It maintained a status quo on rates (by a 4:2 majority) and stance on the grounds that the beast of inflation, though slain, had not been destroyed, and growth, though slowing, remains resilient. Two months later, the MPC, with a new governor at the helm, seems to have pivoted. Why?

The rules are clear. After the shift to ‘flexible inflation targeting’ in 2016, RBI’s mandate has been to keep retail inflation within a 2-6 % band while “keeping in mind the objective of growth." No quibbles on that score. 

But RBI Governor Sanjay Malhotra in his maiden monetary policy statement seems to have focused on the first word, ‘flexible.’ His leitmotif: to make use of the “flexibility embedded in the framework while responding to the evolving growth-inflation dynamics." His predecessor Shaktikanta Das, in contrast, preferred to focus on the last word, ‘target,’ stressing over and over that he saw the target as 4% on a durable basis. And that made all the difference.

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Agreed, the macroeconomic picture ahead of the February meeting of the MPC was vastly different from that in December 2024. On the domestic front, it had to contend with, one, the National Statistical Office’s lower growth estimate for 2024-25 (6.4% as against RBI’s own estimate of 6.6% in December 2024). And two, a Union budget premised on optimistic growth projections that promised to keep the fiscal deficit for 2025-26 at a modest 4.4% of gross domestic product, even while giving a generous boost to consumption through tax giveaways of ₹1 trillion.

On the external front, it had to contend with heightened geopolitical uncertainty caused by the actions of US President Donald Trump. The reality, however, is that if there is one thing that could play havoc with the best laid plans of “men and mice" (read budget projections and RBI’s own reading of future growth and inflation), it is the prospect of incessant trade wars and the attendant broken supply chains. What is undeniable is that the balance of risks has shifted. Though it is not clear as yet which way.

This is as true of India as of the rest of the world, including the US. So, the US Federal Reserve opted to mark time at the Federal Open Market Committee meeting late in January. In the words of Mary Daley, president of the Federal Reserve Bank of San Francisco, the central bank needed to “assess the scope, magnitude and timing" of President Trump’s policies and “does not need to be pre-emptive at this point." Our MPC, however, does not seem to have seen merit in adopting a similar wait-and-watch approach.

Note, the flip side of dollar strength is rupee weakness. And though a weaker domestic currency should help exports, that does not hold in a scenario where protectionist barriers are rising and we’ve already been labelled a “tariff king." 

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A weaker rupee means higher domestic prices for all imports, especially of oil, raising the spectre of imported inflation. Also, the combination of a depreciating rupee and a narrower margin between US 10-year Treasury bonds and our own 10-year government securities is likely to accelerate safe-haven foreign exchange outflows from India, putting further downward pressure on the rupee.

Herein lies the problem with the MPC statement. How, for instance, does one reconcile the heightened risk of imported inflation with its lower inflation projection for 2025-26—4.2% as against 4.8% this fiscal year? 

When quizzed (at the press conference after the announcement of the monetary policy decision) about whether the prospect of higher imported inflation had been factored in while projecting lower inflation in 2025-26, Governor Malhotra shed no fresh light, other than affirming that it had. For now, we will have to rest content with that. And, hope he is right.

On the growth front, it is hard to argue that an economy that grew 6.4% in 2024-25 (and is estimated to grow 6.7% in 2025-26) needs monetary-policy support. Sure, growth in 2024-25 is lower than the 8.2% recorded in 2023-24. But the comparison is misleading as the 8.2% number was distorted by the low base of the previous year (7%).

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Yet, the six-member committee voted unanimously to reduce the policy rate by 25 basis points to 6.25%. Recall that RBI has already initiated a host of liquidity-easing measures, including a cut in the cash reserve ratio (CRR) recently. 

On Friday, the governor also promised banks more time to implement tighter liquidity coverage ratio norms. All of which should help ease the pressure on liquidity. More importantly, these could have given RBI some breathing space to assess how the balance of risks has shifted. Has it shifted sufficiently as to warrant batting on the side of growth rather than inflation?

Given the fog beyond our borders, surely, prudence and the evolving situation made a compelling case to mark time on rates, leaving RBI to manage liquidity in the interim.

The author is is a senior journalist and a former central banker.