RBI’s likely decision to keep interest rates unchanged

Source: The post RBI’s likely decision to keep interest rates unchanged has been created, based on the article “For RBI, a choice: Vegetable prices, growth or currency” published in “Indian Express” on 19th November 2024

UPSC Syllabus Topic: GS paper3-Economy- inflation

Context: The article discusses the RBI’s likely decision to keep interest rates unchanged due to inflation concerns, weak domestic demand, and rupee pressures. It highlights growth slowdown, muted wages, weak private investment, and external factors like U.S. interest rates impacting policy decisions.

For detailed information on The RBI decided to maintain interest rates but change its policy stance read this article here

What is the RBI’s Current Stance on Interest Rates?

1. The RBI is expected to keep interest rates the same because inflation is above their target range.
2. Even though food prices increased, especially for vegetables, the overall inflation without vegetables was low (3.3% in September and 3.6% in October).
3. The RBI fears food inflation could spill over into core inflation through a wage-price spiral.
4. The RBI maintains an optimistic growth forecast, but indicators show a slowdown. Real GDP growth is expected to fall below 7% this year, down from 8.2% last year. Nominal GDP growth could stay below 10% for the second consecutive year.

Why is the RBI’s Concern About Food Inflation Affecting Core Inflation Misplaced?

The concern is misplaced for two reasons.

First, the recent food inflation surge is mainly due to vegetable prices, and excluding vegetables, inflation was only 3.3% in September and 3.6% in October.

Second, significant and persistent food price shocks are needed to affect core inflation, but there is no evidence of such shocks or a wage-price spiral. Labour markets remain weak, wages are subdued, and firm costs are low.

How does the global economy impact India’s policy?

1. Impact of US Fed Rates: The US Federal Reserve cut short-term rates by 75 basis points since September. However, long-term US Treasury yields rose from 3.61% to 4.44%, strengthening the dollar.
2. Capital Outflows: Foreign investors withdrew $14 billion from Indian stock markets in two months, putting pressure on the rupee.
3. Rupee Depreciation: A weaker rupee impacts firms with large foreign currency loans.
4. Policy Constraints: Cutting Indian interest rates could worsen capital outflows and rupee depreciation.
5. Global Trade Policies: Expectations of higher US tariffs under Trump may drive inflation and global uncertainty, complicating RBI’s decisions.

What are the RBI’s key challenges?

The RBI is balancing inflation concerns, growth slowdown, and rupee stability. Currency pressures and weak domestic demand dominate its considerations. The central bank may reassess its policy direction after December, as external and domestic factors evolve.

Question for practice:

Examine how the RBI balances inflation concerns, growth slowdown, and rupee stability in its monetary policy decisions.