India needs monetary easing to sustain cyclical growth recovery

Source: The post India needs monetary easing to sustain cyclical growth recovery has been created, based on the article “Reaching real equilibrium policy rates” published in “Businessline” on 6 May 2025. India needs monetary easing to sustain cyclical growth recovery.

UPSC Syllabus Topic: GS Paper 3-Economy- growth and development

Context: India’s growth slowdown was cyclical, not structural. Growth is reviving due to higher government spending and changing global conditions. This article urges sharper monetary easing, effective liquidity management, and stable exchange rate policy to support growth and manage global spillovers.

For detailed information on India’s Economic Challenges and Policy Adjustments read this article here

Growth Recovery and Monetary Policy Response

1. Signs of a Cyclical Recovery: Growth improved from 5.6% in Q2 FY25 to 6.2% in Q3, supported by public expenditure. This, along with the reversal of the Trump trade, helped strengthen the rupee and equity markets.
2. MPC’s Delayed Action: The MPC failed to cut rates earlier, contributing to the slowdown. Since policy acts with lags, it must anticipate inflation. Inflation fell below target in February, and FY26 projections are at the 4% target.
3. Need for Sharper Rate Cuts: The February cut was timely but too small. A 50bps cut in April was needed to bring real repo rates closer to equilibrium. Market rates have started adjusting, but a bigger cut would improve the pace.

Arguments Against Aggressive Rate Cuts

1. Gradualism in Uncertainty: Some resist sharp cuts, fearing global shocks. But India must recognise its capacity to absorb shocks and respond decisively.
2. Food Inflation and Climate Worries: Fears of heatwaves and food shocks often delay action. However, many States have liberalised agricultural markets, and startups are improving supply chains. Food is also a smaller part of the consumption basket now.
3. Bank Concerns Over Margins: Banks are cautious due to slow deposit growth. They prefer surplus liquidity before cutting lending rates. Yet their profits remain strong as borrowing costs fall and treasury gains rise.
4. Market Focus vs Real Sector Needs: Markets obsess over nominal rates, but the MPC must prioritise real rates that drive consumption and investment. Banks ultimately benefit as the economy grows, regardless of rate direction.

Liquidity Management and Banking Reforms

1. New Liquidity Perspective: The RBI has injected significant liquidity recently. The approach is shifting from ‘liquidity first’ to ‘liquidity fast,’ showing readiness to respond to shocks.
2. Maintaining Surplus Liquidity: Durable surplus liquidity suits India’s conditions of external shocks and weak inter-bank lending. The RBI’s accommodative stance restricts it to pausing or cutting rates.
3. Avoiding Overreaction: Rate cuts and liquidity injections must be measured. Over-stimulation leads to future tightening and volatility. A low, positive real repo rate supports demand while balancing saver and investor interests.

Exchange Rate Trends and Policy Response

1. Reversal of Rupee Outflows: After initial FPI outflows in Jan–Feb 2025, inflows resumed in March. Debt inflows also returned, despite narrowing US-India rate gaps. The rupee appreciated above 85 as reserves were rebuilt.
2. Strategic RBI Intervention: The RBI intervened only to prevent excess volatility, using reserve buffers strategically. This policy restored rupee stability.
3. Balancing Volatility and Stability: Some volatility helps markets and hedging, but excess volatility hurts exporters and widens rate spreads. The RBI must ensure real alignment, not cater to market demands for volatility.

Exchange Rate Management and Structural Factors

1. Real Exchange Rate Alignment: A real effective exchange rate near 100 supports trade. Sustained misalignment must be avoided. Adjustments also reflect Renminbi’s weight in trade indices.
2. Limits of Global Models: Standard theories often misjudge India’s structure. For instance, interest rate links with the US hold only in economies with open capital accounts.
3. Policy Coordination Over Conflict: A central bank–government conflict arises only if fiscal deficits fuel inflation. India is cutting deficits and spending wisely. Hence, monetary policy must quickly use available space to reduce growth volatility.

Question for practice:

Evaluate how India’s monetary and exchange rate policies are being adjusted to support its cyclical growth recovery amid global and domestic challenges.