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RBI's cautious stance could cost growth, bold rate cuts need of the hour

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Monetary Policy and Inflation in India

Current Inflation Trends

The Consumer Price Index (CPI)-based inflation in India dropped to 3.16% in April and is expected to fall below 3% in May. Despite this, the Reserve Bank of India (RBI) has been slow in reducing the repo rate, maintaining it at 6.5% throughout 2024, with only minor cuts in February and April.

Historical Context

The RBI has a history of being a poor predictor of inflation, often maintaining high real repo rates, which adversely affected economic growth between 2015 and 2019. During this period, real rates averaged +2.2 percentage points, as the RBI's inflation projections were consistently higher than actual inflation.

Response to Covid-19 Crisis

A new RBI team effectively managed the Covid-19 crisis by keeping monetary policy appropriately loose from 2020 to 2022, and began tightening in August 2022 to control inflation, which had risen to 6.7%, exceeding the target.

Previous Inflation Management

Post the global financial crisis of 2008/9, the RBI kept repo rates low, leading to high inflation averaging above 10% from 2009 to 2013. By 2014, the RBI raised the repo rate to 8% to curb inflation, which fell to 4.9% by 2015, helped by a decline in oil prices.

Flexible Inflation Targeting (FIT) Regime

Many attribute the period of low inflation post-2015 to the FIT regime, but analysis shows that inflation was already declining due to tight monetary policy and low oil prices, and FIT had minimal impact.

Current Challenges and Recommendations

  • The RBI needs to improve its inflation forecasting, predicting 4% for FY26, which might be too high considering potential lower oil prices and strong agricultural growth.
  • There's a call for swifter action in reducing the repo rate to avoid previous mistakes. The current rate could be lowered to 5% to promote growth amidst global economic challenges.
  • Despite a GDP growth of 7.4% in Q4 FY25, the RBI should not be complacent and should consider a bolder reduction in the repo rate by 50 basis points to support domestic demand.
  • Tags :
  • Flexible Inflation Targeting (FIT) Regime
  • Monetary Policy and Inflation in India
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