Monetary policy review: RBI should stick to its price stability mandate

That’s the kind of see-saw usually associated with stock markets, not macro numbers like GDP. While the drivers may differ each year, underlying these swings is the ‘base effect,’ a consequence of making comparisons with a ‘base’ year, usually the previous one.

So, last fiscal year’s growth looked rosy in large part because growth in 2022-23 had flagged since 2021-22, when it was 9.7% but on a covid-shrunken GDP base of 2020-21. The same effect will make this fiscal year’s expansion look relatively weak.

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This is not to underplay the economy’s deceleration in the last quarter. High-frequency data had hinted at a moderation in economic activity well before the numbers came in last Friday, just as these indicators now hint of a revival of sorts in the second half of 2024-25.

But what took most observers by surprise was the extent of the slowdown. A related issue is whether this is a transient slump that policymakers—fiscal and monetary—can look through or is it part of a larger cyclical slowdown. If it is the former, there would be no need for any policy action; a knee-jerk reaction might boomerang, creating more problems later.

However, if it is part of a longer phenomenon with weaknesses likely to persist, as weak consumption and investment trends suggest, there would be a case for policy action. The problem with such dilemmas is that decisions have to be taken real time—indeed, often ahead of time, given the lags in policy actions taking effect.

However, the results are only known much later, by which time it is often too late to turn the clock back. As the US Fed and major central banks discovered to their cost when they delayed raising interest rates in the belief that rising inflation in the pandemic aftermath was transitory, only to find that by the time they reversed direction and began to raise interest rates, inflation and—crucially— expectations of it had taken root, resulting in a prolonged phase of steeply rising retail prices.

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This then is the conundrum that faces the Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) when it meets this week from 4-6 December. Its mandate—of price control, keeping in mind the objective of growth—means it’s always a bit of a toss-up between inflation and growth, with the MPC’s priorities shifting from one to the other, depending on the macro situation.

Its task is easy when both inflation and growth are on an uptrend: It must focus on inflation control. But what if inflation is rising (6.2% in October) while economic growth is slowing, as at present? What should it prioritize? Governor Shaktikanta Das has made his preference clear. Until inflation reaches 4% durably, RBI will focus on inflation control.

Not only because sustained growth is not possible without price stability or because the poor bear the brunt of instability, but because keeping inflation in check is RBI’s remit, just as growth is primarily the government’s. The central bank must stick to its knitting. This means retaining its status quo on rates for now, even if it uses other tools at its disposal to ease liquidity conditions.

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