Minutes Show Growth Is MPC’s Clear Priority As Long As It Can Avoid Inflation Failure

The Reserve Bank of India’s Monetary Policy Committee may have finally relented and cut the repo rate earlier this month by 25 basis points, but it is still being debated whether the current easing cycle will be as shallow as 50 basis points or as large as 100 basis points or more. This is because of the clouds surrounding three key issues.

The first is inflation, which has only recently dropped below the upper bound of its 2-6% tolerance limit. Headline retail inflation is projected to drop to 4.2% in 2025-26, but after five years of 4%-plus inflation, price rises can’t be taken lightly.

The second hurdle is growth, which crashed to a seven-quarter low of 5.4% in July-September 2024 and is estimated at a four-year low of 6.4% in 2024-25. As multiple members of the MPC mentioned in the minutes of the February 5-7, 2025 meeting, tight monetary policy is hurting growth. 

Taken in conjunction with falling inflation, the real policy rate has risen considerably. 

Real Rates
Central bank watchers can’t even be sure what real interest rate MPC members are looking at. Is it the repo rate minus current CPI inflation? Or the repo rate minus one-year-ahead inflation per the central bank’s forecast? Or the 364-day Treasury Bill rate minus one-year-ahead inflation forecast? Or maybe the target inflation rate of 4% minus the one-year-ahead inflation forecast? Or perhaps the repo rate minus a mix of current retail and wholesale inflation? 

All of the above have been used by members of the MPC at some point or the other in the last 10 years to justify their decisions, with Governor Sanjay Malhotra seemingly introducing the fifth and final one on February 7, 2025 when asked about the real interest rate. 

Different definitions lead to different answers, which result in varied views on the potential room the MPC has to reduce the policy rate.

The final driving force when it comes to the uncertainty over the size of the easing cycle is the fact the repo rate hasn’t been all that high to begin with; it’s not like it was 7-8%. The repo rate was 6.50% as recently as 2019 before it was reduced to 5.15% over the course of the year as growth fell sharply even before the coronavirus pandemic struck. In fact, ever since the flexible inflation targeting framework was effectively adopted in early 2014 and until the start of the pandemic, the annual average repo rate has been 6.65%.

However, what the minutes of this month’s MPC meeting show is that policymakers are willing to throw caution to the wind. External member Nagesh Kumar thought the committee could be “more ambitious and target a 50 basis point cut” to show that India would do “whatever it takes to revive economic growth momentum”, with Ram Singh warning growth is “significantly below the potential growth rate”. Saugata Bhattacharya was of the opinion the MPC’s response on the inflation-growth trade-off was skewed in favour of growth. RBI Executive Director Rajiv Ranjan went one step further and said the time had come “to accord higher weight to growth in our policy setting”. Newly—appointed Governor Sanjay Malhotra and Deputy Governor M. Rajeshwar Rao—holding temporary charge of the Monetary Policy Department—held their cards close to their chest even as they voted for a rate cut.

MPC members’ concerns about growth were matched by the Economic Survey for 2024-25, which called on the private sector to invest in R&D and ensure wage growth matched increases in profit so that demand was sustained. But 25-50-basis point reductions in the policy rate don’t do anything to boost demand. What is needed is a bigger push. 

While the MPC will never assign a number to the quantum of rate cuts it may be considering, nothing will be off the table as long as there is no failure to achieve the inflation mandate and the repo rate does not fall below the unofficial floor of 4.00%.