RBI should cross over by feeling the stones in its approach to a rate cut

The first is that one blindly follows the other. The other is that each takes its cue from the other. The nuance here is that it is informed, but not driven, by the other. Of course, there could be a crisis, like covid, when both must work in close coordination to rescue a cratering economy. But when it’s business as usual, each must stay true to its own mandate. 

Also Read: This budget is remarkable for its fiscal restraint—apart from other aspects

Fiscal policy must address issues of growth and equity. And monetary policy, under the inflation-targeting regime adopted in 2016, must ensure price stability—for which the cost-of-living must rise only in a band of 2-6% annually—with the objective of GDP growth also kept in mind.

So, what does this mean for MPC deliberations, which begin on Tuesday, now that the budget has done its bit to support growth? Some might argue that an economy that is slated to grow 6.4% this fiscal year and in a range of 6.3- 6.8% next year, according to the 2024-25 Economic Survey—making India one of the world’s fastest growing major economies—does not really need a booster shot. 

While the budget’s fiscal tightening may seem to offer space for a policy rate cut, a direct fiscal stimulus of ₹1 trillion via tax relief could potentially stoke prices. This risk would get amplified if the growth assumptions that underpin the budget math are not realized. 

Also Read: Ajit Ranade: The budget’s consumption stimulus will stand India in good stead

The budget’s effort to reverse a loss of pace in the economy, while well crafted, needs to come good. It may thus be best to wait and watch. Action could be taken after some clarity arises over how things are likely to pan out—not just on that front, but also in the context of the trade and currency turmoil that US policy is pushing the world into. Inflation imported on the back of a strong dollar is a threat.

Although rising retail price levels have cooled off a bit over the last two months, retail inflation remains stubbornly above 5%, so we are still far from the MPC’s stated goal of inflation held durably at 4%.

The central bank has already done a great deal to address the market’s liquidity tightness. At its December MPC meet, it reduced the cash reserve ratio by a hefty 50 basis points, thereby releasing ₹1.16 trillion of additional liquidity into the system. 

Also Read: Indian banks’ liquidity crunch is partly RBI’s own doing

More recently, it announced liquidity-easing measures to the tune of ₹1.5 trillion. It should allow some time for these measures to work their way around. 

Notably, the US Federal Reserve, the global economy’s de facto central bank, held rates unchanged at its last meeting, despite political calls to cheapen credit. Any reduction in RBI’s repo rate will weaken the investor appeal of Indian government securities vis-a-vis US Treasury bonds, possibly setting off a rush of portfolio outflows. 

Given the many unknown unknowns we now face, plus the budget’s stimulus aimed at consumer spending, India might be served best if the MPC were to bide its time for now. It should heed an old Chinese saying: ‘Cross the river by feeling the stones.’