Opinion On interest rates, why RBI decided to err on the side of caution

For the eighth-time in a row, the Reserve Bank of India has opted to maintain the status quo on the benchmark interest rates. As such, the repo rate, the interest rate at which the RBI lends money to commercial banks, will remain at 6.5 per cent. The RBI’s primary objective in deciding the repo rate is to maintain price stability in the economy. By law, it has to target a retail inflation level of 4 per cent. The secondary objective for the RBI is to promote growth. Given that retail inflation is still above 4 per cent while GDP growth was above 8 per cent for the financial year 2023-24, this decision seems reasonable. But, looking ahead, while the RBI appeared more sanguine about India’s growth, it was also a little more concerned about the stickiness of retail inflation.

On GDP growth, the RBI upped its forecast for the current financial year from 7 per cent to 7.2 per cent. In response, the benchmark Sensex soared by more than 1,720 points (or over 2 per cent) to hit a life-time intraday high of 76,795. The RBI noted that high frequency indicators of domestic activity are showing resilience in 2024-25. “The south-west monsoon is expected to be above normal, which augurs well for agriculture and rural demand. Coupled with sustained momentum in manufacturing and services activity, this should enable a revival in private consumption. Investment activity is likely to remain on track, with high capacity utilisation, healthy balance sheets of banks and corporates, government’s continued thrust on infrastructure spending, and optimism in business sentiments,” the MPC said.

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However, on inflation, its primary concern, the RBI seems to have some worries. It is not as if inflation is not trending down — headline inflation has seen sequential moderation since February 2024 — but this decline has been in a very narrow range, from 5.1 per cent in February to 4.8 per cent in April. This has led to a growing divergence within the RBI’s six-member Monetary Policy Committee, with two members voting for a cut in interest rate while the other four choosing to stay put. Clearly the hawks (members who are more bothered about inflation rearing its head once again) continue to dominate the doves (members who take a more benign view of inflation prospects) within the MPC. When questioned, Governor Shaktikanta Das clarified that the RBI’s goal is not to cut rates as soon as they touch the 4 per cent mark, rather to cut when the policymakers are convinced that inflation will stay at or around that level sustainably. High inflation, especially food price inflation, has been a crucial concern among voters in the just-concluded elections. Given the all-round uncertainty, both global (geo-political tensions) and local (rising incidence of adverse climate events on food prices), the RBI has wisely decided to err on the side of caution.