Real repo rate too high and could hurt growth, said MPC dissenters

The two external members of the Reserve Bank of India (RBI) Monetary Policy Committee (MPC) who had pushed for a 25 basis point rate cut at the June 7 meeting, Ashima Goyal and JR Varma, said the real repo rate at 2% was too high and could hurt growth, according to the minutes released by the central bank on Friday.

The six-member committee had voted four to two to keep rates unchanged for the eighth straight review amid inflation concerns fuelled by worries about a rise in food prices.

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“The headline inflation projection of 4.5% for 2024-25 gives an average real repo rate of 2%, implying that the real repo rate will be above neutral for too long if the repo rate stays unchanged,” said Goyal, emeritus professor at the Indira Gandhi Institute of Development Research. “Falling inflation has raised real repo above unity. This will reduce the real growth rate.”

Varma, professor at the Indian Institute of Management, Ahmedabad, echoed her views.

“As I have stated in the last several meetings, the current real policy rate of around 2% (based on projected inflation) is well above the level needed to glide inflation to its target,” he had said. “I therefore vote to reduce the repo rate by 25 basis points, and to

change the stance to neutral.”

However external member Shashanka Bhide and the other three internal members were of the view that India’s growth trajectory was strong and created space for monetary policy to focus on inflation. Bhide is honorary senior advisor, National Council of Applied Economic Research.

Going by the majority verdict, the MPC decided to keep the benchmark policy rate unchanged at 6.50% and retained the monetary focus on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth.

“These decisions are in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4% within a band (of plus or minus 2 percentage points), while supporting growth,” the RBI said.

The growth-inflation balance is moving favourably in line with our projections, governor Shaktikanta Das was cited as saying in the minutes.

“Resilient growth creates space for monetary policy to focus unambiguously on inflation which remains well above the 4% target,” he said. “With persistently high food inflation, it would be in order to continue with the disinflationary policy stance that we have adopted.”

However, Goyal argued that inflation had slowed in the past through supply side action and anchoring of inflation expectations with the real policy rates at neutral without a large growth sacrifice.

“Why then would higher real policy rates be required now to fight inflation that is lower? The sacrifice ratio from real policy rate above neutral is very high when aggregate supply is elastic as it is in India,” she said.

Deputy governor Michael Patra said that with output in broad balance in relation to its potential, monetary policy can remain neutral to growth at this juncture and stay focused on aligning inflation to the target.

“Economic activity in India is evolving broadly in line with the baseline projection,” Patra said. “Prospects of a favourable monsoon should offset the slackening momentum that has become a typical feature of first quarter GDP out-turns in the post-pandemic period. Domestic demand should continue to drive the economy, with private consumption receiving a fillip from the revival in rural spending.”

With persistently high food inflation, it would be in order to continue with the disinflationary policy stance that the central bank has adopted, according to Das.

“Any hasty action in a different direction will cause more harm than good,” he said. “It is important that inflation is durably aligned to the target of 4%. Price stability is the bedrock for high and sustainable growth.”