RBI to Cut Interest Rates after Two Years?

As India's retail inflation shows signs of cooling down in December, the Reserve Bank of India (RBI) faces an important question ahead of its next Monetary Policy Committee (MPC) meeting from February 5 to February 7: will growth take precedence over inflation in its policy stance? With the goal of achieving 'Viksit Bharat' (Developed India) by 2047, the country needs consistent growth above 8%, but recent inflationary pressures have dominated RBI’s decisions.

Inflation: The Driving Force Behind RBI's Policies

Inflation, particularly driven by rising food prices which have crossed 9%, has been the central focus of RBI's recent policy actions. The steep rise in food inflation has put immense pressure on household budgets across the country.

Before the December MPC meeting, Finance Minister Nirmala Sitharaman pushed for a rate cut to boost economic growth. Commerce Minister Piyush Goyal even stated that considering food prices in deciding interest rate policies was a "flawed theory." However, RBI's Governor, Shaktikanta Das, emphasized that growth was impacted by a variety of factors, not just the repo rate, during his farewell media interaction last month. Restoring a balance between inflation control and economic growth remains a key challenge for the RBI.

The Government vs. RBI: Diverging Stances

The finance ministry has expressed concerns over the RBI's policies, with the November economic review pointing out that the RBI's stance, along with macroprudential measures, may have contributed to a demand slowdown in the first quarter of FY25. India’s GDP growth for FY25 is expected to be 6.4%, falling short of the growth projections by both the RBI and the government.

As the RBI keeps the repo rate at 6.5% and adopts a neutral stance, it has room for flexibility in response to shifting economic conditions. However, the ongoing debate between the RBI’s inflation-centric policies and the government’s growth-focused approach continues to intensify.

New Concerns: Rupee Depreciation

Alongside inflation, a new challenge has emerged: the depreciation of the Indian rupee. Recently, the rupee hit an all-time low, breaching the Rs 86 per dollar mark. While the RBI has signaled a readiness to let the rupee fluctuate in line with regional currencies, it remains prepared to intervene in case of excessive volatility in the forex market.

Global shifts, such as the return of Donald Trump to the White House, have raised concerns about potential policy changes in the United States, which could affect India’s currency. The rupee has already depreciated by 3% against the dollar since Trump’s victory in November. These international developments further complicate the RBI’s decision-making process.

Balancing Growth and Inflation

As the February MPC meeting approaches, the central question remains: will the RBI prioritize economic growth or continue to focus on controlling inflation? According to independent economist Prithviraj Srinivas, the government and RBI must first assess whether India has the institutional framework to sustain over 8% growth before pushing the accelerator.

RBI’s priority should be sustainable economic growth without sacrificing price stability, ensuring a long-term path to prosperity. While growth and inflation are interconnected, economists argue that pushing growth at the expense of inflation could have unintended consequences, such as eroding purchasing power, especially among lower-income groups.

The Path Ahead: Cautious Optimism

Many economists expect the RBI to maintain a cautious approach in its upcoming policy review. Aditi Gupta, an economist at Bank of Baroda, suggests that the global developments, particularly in the U.S., are likely to have limited direct impact on India. However, they could contribute to increased volatility in financial markets, affecting India's economy in the short term.

Gupta also notes that emerging inflation risks may lead the RBI to explore alternative measures, such as easing liquidity in the banking sector, rather than cutting interest rates. This could help stimulate growth while managing inflation.

The Risk of Growth-Oriented Policies

Economists caution that focusing too heavily on growth could undermine the battle against inflation, which is crucial for maintaining external competitiveness and real income growth. As inflationary pressures remain a concern, the RBI's challenge will be to strike a balance that fosters growth without compromising price stability.

With the February MPC meeting drawing near, all eyes are on the RBI’s decision. Will it prioritize immediate growth stimulus, or wait for clearer economic signals? As the debate continues, the outcome of the meeting will shape the trajectory of India’s economic future.