Opinion Low inflation gives RBI space to support growth

In the run-up to the December meeting of the RBI’s Monetary Policy Committee, there was a heated debate on what the committee ought to do. The meeting was being held against the backdrop of a peculiar situation — high real growth, record low inflation, and a falling rupee. Recent data showed that the Indian economy grew at a robust 8.2 per cent in the second quarter of the year. Strong growth was observed across all sectors — agriculture, manufacturing and services. However, nominal GDP growth was just 8.8 per cent during the year’s first half —considerably lower than the 10.1 per cent assumed in the Union budget. On the other hand, retail inflation has been trending lower. In fact, it has remained below the central bank’s target since February this year. The rupee, which has been falling against major currencies, breached the 90 mark against the dollar. The MPC, after holding steady over the last two meetings, lowered interest rates, and rightly so, by 25 basis points.

Price pressures remain muted in the economy. The central bank’s own estimates peg inflation to average just 2 per cent this year. Excluding gold, core inflation was at 2.6 per cent in October, signalling that the “decline in inflation has become more generalised”. The inflation forecasts also do not indicate any big buildup of price pressures in the economy over the coming quarters. On a forward-looking basis, the real repo stands at around 1.25 per cent. However, on growth, the RBI appears to be cautious. While the central bank notes that high-frequency indicators do suggest that economic activity is holding up in the third quarter, it also says that “there are some emerging signs of weakness in a few leading indicators”. Uncertainties on the external front — goods exports declined in October — do pose downside risks. The central bank has projected growth to soften to 7 per cent in the third quarter and 6.5 per cent in the fourth quarter.

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With limited fiscal space, after the recent tax cuts, and headwinds on the external front, the heavy lifting has to happen through monetary policy. The central bank must also ensure sufficient liquidity for effective rate transmission — it has announced measures to boost liquidity in the economy. With inflation under control, how growth shapes up in the coming quarters will determine the future course of policy.