(Bloomberg) -- India’s central bank said it’s better to focus on bringing inflation down to the 4% target than to ease monetary policy to boost economic growth in the short term.
“Given the high uncertainty shrouding the inflation outlook, it is prudent to eschew the temptation of time inconsistency and stay the course on the straight and narrow path of aligning inflation with the target of 4%,” the Reserve Bank of India said in its monthly bulletin Thursday.
Reneging on its commitment to fight inflation may result in the central bank “losing credibility, unhinging inflation expectations and triggering a surge in inflation,” while undermining growth sustainability, the RBI said in the State of the Economy section of the report.
Inflation in June accelerated to a four-month high of 5.08%, a full percentage point above the RBI’s target. The central bank has kept its policy interest rate unchanged at 6.5% for more than a year already. Governor Shaktikanta Das said last week it was “too early to talk about interest rate cuts.”
In its report, the RBI blamed high inflation on persistent spikes in food prices, and said vegetable inflation is becoming enduring in nature.
“Food prices are clearly dominating the behavior of headline inflation and households’ inflation expectations, undermining the gains of lowering core and fuel inflation through a combination of monetary policy and supply management,” the RBI said.
The central bank, though, said economic momentum is gathering pace. Good monsoon rains have improved sowing and will help revive demand in the rural economy.
“The improvement in the outlook for agriculture and the revival of rural spending have turned out to be the bright spots in the evolution of demand conditions,” it said.
Natural Rate
A separate study by senior RBI staff found India’s neutral or natural rate of interest — the interest rate at which an economy can grow at full capacity without fueling inflation pressure — has climbed to 1.4%-1.9% now, from 0.8%-1.0% during the pandemic period of October-December 2021.
With the RBI’s real policy rate already within that range for neutral rates, that “might explain why the Monetary Policy Committee has not shown any urgency to ease policy,” Citigroup Inc. economists wrote in a note. Citi has pushed out its prediction for a rate cut to April 2025, adding that it’s likely to be a “shallow” easing cycle of about 50 basis points.
The paper in the RBI report was authored by Harendra Kumar Behera from the Department of Economic and Policy Research and is not an official view of the RBI. But it was written under the guidance of the RBI’s deputy governor in charge of monetary policy, Michael Patra, giving the findings some heft.
“When the policy rate is set below the natural rate, the stance is regarded as accommodative, and the converse signifies a restrictive stance,” according to the paper. “The policy stance is neutral when the real policy rate is at the level of the natural rate.”
With inflation expected to moderate close to 4% in the coming months, the inflation-adjusted, or real interest rate, will increase from its current level of 1.42% if the RBI’s policy rate is left unchanged.
Two of the six members of the MPC voted for a rate cut last month, while a third policymaker said in an interview that a high real rate isn’t conducive for growth.
--With assistance from Preeti Soni.
(Updates with comment from economists in second paragraph under sub-headline.)
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