Views expressed in the latest rate-setting meeting of RBI include those who feel the repo rate is high and needs to be cut. Two external members of the six-member Monetary Policy Committee (MPC) made a strong pitch for cutting the rate, held at 6.5% since February 2023, minutes of the June meeting released last week showed. These two members, reports said, also favoured a change in the policy stance from withdrawal of accommodation to neutral. There are two aspects to the minority view in RBI’s MPC for a rate cut. One, as inflation trends downwards, the real repo rate is increasing so long as RBI holds the line. Two, there could be a sacrifice in economic growth on account of interest rates staying higher for longer. The majority view sees inflation control becoming tougher as it approaches the target and is wary of spikes in food inflation.
If RBI continues to hold rates, it will be subjecting the economy to a 2% real repo rate, almost double what is a growth-oriented level. The economy grew above 8% last year as the real repo rate was climbing towards 2%. Growth projections for the current year have been trimmed as higher-for-longer interest rates work their way through the system. The question MPC’s rate-cutters are posing is whether this sacrifice in growth is worth it. After all, a high repo rate does little to tame food inflation. Core inflation, excluding volatile food and energy prices, does not justify the interest rate level.The risk of inflation overshooting its target may have a lower impact on economic growth in a scenario of a slow rise in real wages. A revival in consumption and investment will be needed to keep the economy growing at 8%. Any further slowdown in consumption has spillover effects on investment, which may warrant RBI’s caution over lowering interest rates till inflation is at or below target. The inflation target may need to be reset if the economy can sustain higher growth rates at lower inflation levels. Structural changes in the economy make that possibility not too distant.
