A growing chorus for rate cut from Delhi to be RBI's next challenge

Reserve Bank of India governor Shaktikanta Das

If you thought that making of monetary policy has become sufficiently independent of political pressure, because it is being set by a committee of 6 persons who are governed only by data and by a parliament-given mandate of getting inflation to 4 percent, then think again

In the past few months and especially in the past few days, the pressure from Delhi on the Reserve Bank and its Monetary POlicy Committee (MPC), to cut interest rates has been growing. The first hint came in the Economic Survey, where in a box item, the Chief Economic Advisor (CEA) asked if the mandate to the MPC to bring inflation to 4 percent should exclude food inflation. The CEA argued, as many worthy experts before him, that food prices rise due to climate and other reasons and are not amenable to being brought down by interest rates. So should the MPC be given a core-inflation target (i.e. one which excludes food and fuel)?.

Some bravehearts (and blinkered minds) dismissed this as the CEA's own view and not that of the government. After all the CEA is a technocrat, and he had on previous occasions argued in newspaper columns that he was opposed to the flexible inflation targeting regime that was put in place in 2015.  Also in July, there was no urgent need or call for rate cuts since growth was robust. Even the Fed hadn't cut rates and so the debate was seen as academic.

Govt's rate cut clamour grows as RBI governor's term nears end

But there is nothing academic about the pressure on RBI from the commerce minister and the finance minister in the past week. On Thursday November 14, speaking at the CNBCTV18 Global leadership Summit, commerce minister Piyush Goyal demanded in no uncertain terms that the RBI should cut rates. Taking a cue from the Economic Survey's box item, the minister argued that "food inflation has nothing to do with managing inflation". "It’s time that policy makers & monetary policy authorities sit together and decide if food inflation needs to be part of calculating headline inflation," he argued emphasizing that ,"there should be a serious thought on this"

As if on cue, on November 18, at the SBI conclave, to a question raised by CNBCTV18's Editor, Shereen Bhan, finance minister Nirmala Sitaraman said food prices are dictated by global supply issues and added that ,"We need to have more conversation on inflation- interest rate dynamics". She concluded by generally asking banks to make rates more affordable. But the key takeaway was the nudge to RBI to re-examine the interest rate-food inflation connection and possibly consider cutting rates sooner rather than later.

Possibly, the ministers are worried about the tell tale signs of slowdown in the economy: IIP (or the index of industrial production) fell to a multi year low of -0.1 percent in August. Core sector output, auto sales & PMI (or purchasing managers' index) readings have also been softening through the July-September quarter. GST collections in September also rose only 6 percent, against estimated nominal GDP growth of 11 percent this year. The Q2 results rammed home the severity of the growth slowdown - Nifty companies' earnings grew by only 4 percent - the second consecutive quarter of low single digit growth!

The market is beginning to discern the pattern: as growth fears grow, the government is looking for all the help it can get. And an RBI chasing inflation down by keeping real rates as high as 200 basis points is beginning to look like the villain of the piece. The CEA, while refraining to comment directly on monetary policy, at the SBI Conclave, clearly explained that the higher 6.2 percent inflation in October was largely because of 5 elements:  potatoes, tomatoes, onions, gold and solver. He didn't say, but abundantly implied that high rates can't control vegetable inflation or the global precious metals prices, which are a function of dollar, geopolitics and the flight to safety.

Despite this mounting pressure from the political authorities, it is tough to see the RBI and the MPC buckling and cutting rates at the December 6th policy meeting. But the mounting pressure and the expected fall in India's CPI and the falling global crude prices can set the stage for a February rate cut.

The pressure on RBI comes at a vulnerable moment. The three new MPC members are newbies ,(appointed as recently as in September 2024) and may be unable to handle the diktat from Delhi. Deputy governor Michael Patra who has been the only one (other than RBI governor Shaktikanta Das) to have been member of the MPC since its inception is also due to lay down office in end-January 2024. An eminent economist and one of the authors of the inflation targeting framework, Patra contributed seminally to navigating monetary policy during the early years of the new framework. The absence of his academic rigour and sagacity will make it tougher for the MPC, post-December, to fend off the pressures from New Delhi.

What's worse, governor Das himself may bow out of RBI on December 10, if the government doesn't renew his term. It is unlikely Das will oblige with a cut even if he has a whiff that his term may not be renewed. He can't cut rates when the headline CPI has actually risen to 6.2 percent in October, the last month for which data would be available when the MPC meets on December 4-6. Governor Das knows too well the price of RBI's hard-won credibility.

Yet governor Das has an unenviable role. He is very much seen as likely to get a further 2-year term extension and hence some in the market are already wondering if the government is setting him a price for his continuation. These are probably market hallucinations. But perception is a large part of policy setting.

The casualty probably is institution building. "The flexible inflation targeting regime ensures independence of monetary policy making," former RBI governor  C Rangarajan had told CNBC-TV18 in an interview on August 15 this year. "Under this regime, neither the governor nor the finance minister can have control over monetary policy, as rates are set by an independent committee of six members who have a mandate given by  Parliament to set interest rates in such a way, as to bring inflation to 4 percent", argued the learned governor, well known as an inflation warrior himself.

To be fair there are other equally competent governors like Y V Reddy who have argued that an explicit inflation target for a central bank in a country where food forms a large part of the CPI index is questionable.

On the flip side, the flexible inflation targeting (FIT) regime has served the country well as it allowed the RBI to cut rates sharply when Covid pushed down growth and pushed up inflation. The RBI and its MPC correctly argued that they would look through the supply driven inflation during the Covid months. The FIT regime has earned India the trust of foreign bond investors and is a big reason why Indian bonds have gotten included in global  bond indexes. The FIT regime has won all-round praise for India's strong macros.

North Bloc must think again, if it wants to sacrifice so much to counter a seemingly seasonal slowdown in growth. Debates on food inflation and interest rates as also politicians blaming central banks for slow growth are part of the course. But these must not be pushed so hard that the hard won gains of trust and strong macros are lost.