 |
|
The Reserve Bank of India (RBI) finds itself navigating a complex economic landscape, marked by fluctuating inflation rates, global uncertainties, and the persistent challenge of transmitting policy decisions effectively through the financial system. The article highlights several noteworthy aspects of the RBI's recent monetary policy decisions, particularly the unexpected rate cuts and the abrupt shifts in its policy stance. These actions raise questions about the central bank's priorities and the effectiveness of its tools in stimulating economic growth while maintaining price stability. One of the most surprising moves was the 50 basis point rate cut announced in June, a significant reduction that came shortly after the RBI had adopted an accommodative stance. This shift in stance, from accommodative back to neutral in a short period, suggests a degree of uncertainty or a reassessment of the economic outlook within the RBI. Governor Sanjay Malhotra's statement that the trade-off between price stability and growth is only a short-term concern further underscores this evolving perspective. The article points out that in April, the RBI's accommodative stance implied that rates were likely to remain unchanged or decrease. However, the June rate cut was accompanied by a cautious statement indicating limited room for further monetary easing to support growth. This creates a mixed message, potentially dampening market expectations for future rate reductions. The RBI's actions could be interpreted as either an attempt to catch up for previously missed opportunities or a deliberate effort to manage market expectations by tempering enthusiasm for further rate cuts. The timing of the rate cuts is particularly interesting given the upward trend in core inflation. While headline inflation has been declining, core inflation, which excludes volatile food and fuel prices, has been inching up. This situation presents a challenge for the RBI, as it raises concerns about underlying inflationary pressures in the economy. The article notes the irony that just a year prior, there was pressure on the RBI to focus on core inflation to justify rate cuts. Now, the RBI faces the opposite scenario but remains seemingly unfazed, attributing the rise in core inflation primarily to rising gold prices. This explanation is itself somewhat ironic, as gold is often considered a hedge against inflation. However, current price movements of gold suggest a flight to safety in response to global economic uncertainties, rather than purely an inflation-driven phenomenon. The RBI's relatively sanguine view on inflation is reflected in its revised estimate for 2025-26, which has been lowered to 3.7% from an earlier 4%. This optimistic outlook is based on the expectation of favorable food prices due to bumper harvests and a normal monsoon, as well as the beneficial impact of low commodity prices resulting from global economic turmoil. However, these assumptions are subject to various risks and uncertainties, and any significant deviation could alter the inflation trajectory. The article also raises concerns about the effectiveness of the RBI's liquidity measures. The 100 basis point cut in the Cash Reserve Ratio (CRR) was a surprise, especially given the existing surplus liquidity in the system, which has been boosted by the RBI's infusion of Rs 9.5 lakh crore since January 2025. The CRR reduction is expected to inject another Rs 2.5 lakh crore into the system by December 2025. The rationale behind this move appears to be that if policy rates are ineffective, market forces might step in to stimulate growth. However, the article questions whether this additional liquidity will translate into a credit boom and whether it could potentially fuel inflation. The RBI acknowledges that the transmission of rate cuts to lending rates has been weak, with lending rates dropping by only about 6 bps in response to the earlier 50 bp repo rate cut. This suggests that factors other than the cost of credit are hindering credit growth. Data from the RBI also reveals that during the tightening phase (May 2022-Jan 2025), both deposit and lending rates increased almost as much as the rate hikes (250 bp). However, in the current easing phase (50 bps rate cut between Feb- March 2025), deposit rates have actually increased, while lending rates have barely moved. This asymmetry indicates that banks are reluctant to lower lending rates despite the reduction in policy rates. The liquidity-inflation nexus is another area of concern. While forex inflows from Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI) may currently be muted, a surge in these flows could rapidly shift the focus from enhancing liquidity to containing it, particularly if inflation rears its head again. Forex assets have been a major driver of M3 growth in the economy, and large FX inflows could exacerbate inflationary pressures. The RBI's GDP growth estimate of 6.5% for 2025-26 appears reasonable, given the current economic performance. The central bank believes that domestic growth drivers are robust and that global uncertainties pose the primary downside risks. However, the RBI also seems to be acknowledging the limitations of a bank credit-fueled growth model, suggesting that other factors may be necessary to sustain long-term economic expansion.
The article highlights the importance of personal credit growth in driving a potential credit boom. Data on capital formation indicate that households and the informal sector are increasingly taking the lead in investment, with much of this investment directed towards homes, buildings, and roads, rather than plant and machinery or capital assets. This suggests that personal credit, particularly for housing and consumption, will be crucial for stimulating economic activity. The RBI's recent backtracking on some regulatory measures that had previously restricted gold loans and lending to Non-Banking Financial Companies (NBFCs) could further boost personal credit growth. However, the ultimate impact of these measures depends on how effectively and quickly rate cuts are transmitted through the credit system, a question that remains uncertain. Overall, the article paints a picture of an RBI grappling with a complex and uncertain economic environment. The central bank's recent policy decisions, characterized by rate cuts, shifts in stance, and liquidity measures, raise questions about the effectiveness of its tools in achieving its dual mandate of promoting economic growth and maintaining price stability. The challenges of weak credit transmission, rising core inflation, and global uncertainties underscore the need for a cautious and data-driven approach to monetary policy. The success of the RBI's efforts will depend on its ability to navigate these challenges effectively and to adapt its policies as the economic landscape evolves.
In conclusion, the RBI's journey through the economic currents of 2025 is a testament to the ever-evolving nature of monetary policy in a globalized world. The central bank's actions, as highlighted in the article, are not simply responses to immediate pressures but also strategic maneuvers aimed at shaping future economic outcomes. The complexities of balancing growth with price stability, managing liquidity in a fluid market, and ensuring effective transmission of policy signals are all intertwined, presenting a multifaceted challenge for the RBI. The article astutely points out the potential for conflicting signals emanating from the RBI's policy decisions. The rate cuts, designed to stimulate growth, are juxtaposed with concerns about rising core inflation and the limits of monetary policy. This delicate balancing act requires careful communication and transparency from the RBI to maintain market confidence and avoid unintended consequences. The reliance on assumptions, such as favorable food prices and stable commodity prices, underscores the inherent uncertainty in economic forecasting. While these assumptions may be valid in the short term, unforeseen events could disrupt the economic trajectory and necessitate a recalibration of monetary policy. The article's emphasis on the role of personal credit in driving economic growth is particularly insightful. As households and the informal sector take the lead in investment, the availability and affordability of credit become crucial determinants of economic activity. The RBI's efforts to ease lending conditions, while commendable, must be accompanied by measures to ensure responsible lending and prevent excessive risk-taking. The weak transmission of rate cuts to lending rates remains a persistent challenge. This suggests that structural factors, such as bank profitability and risk aversion, are hindering the effectiveness of monetary policy. Addressing these structural issues will require a broader range of policy interventions, including regulatory reforms and measures to improve financial intermediation. The liquidity-inflation nexus is another critical consideration for the RBI. While ample liquidity can support economic activity, excessive liquidity can fuel inflation and destabilize the financial system. The RBI must carefully monitor liquidity conditions and be prepared to take swift action to contain inflationary pressures. The global uncertainties highlighted in the article underscore the interconnectedness of the global economy. Events in one part of the world can have significant repercussions for India's economic prospects. The RBI must remain vigilant in monitoring global developments and be prepared to adjust its policies accordingly. The RBI's journey is not without its ironies. The central bank, once pressured to focus on core inflation to justify rate cuts, now faces the opposite challenge. This highlights the importance of maintaining a flexible and data-driven approach to monetary policy. The article's concluding message is that the RBI's success will depend on its ability to navigate the complex and uncertain economic landscape effectively. This requires a combination of sound judgment, clear communication, and a willingness to adapt policies as the economic situation evolves.
Source: Lost in transmission