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As the Reserve Bank of India’s Monetary Policy Committee (MPC) assesses the economic landscape, external members Ashima Goyal and Jayanth Varma have sounded caution about the trajectory of real interest rates, emphasizing the need for policy calibration. Their concerns come in the wake of discussions about inflation dynamics and the potential impact on the Indian economy.

In the latest MPC meeting, held on December 6, both Goyal and Varma stood out by recommending a policy repo rate cut, contingent on inflation aligning with the mandated 4 percent target by 2024. While other committee members stressed the importance of monitoring inflation, especially in the context of volatile food prices, the overall decision was to maintain the policy repo rate at 6.5 percent for the fifth consecutive time.

Goyal expressed apprehension regarding robust economic growth without a corresponding uptick in core inflation, which dipped to 4.8 percent in the second quarter of the fiscal year from the previous fiscal’s 6.1 percent. Core inflation, which excludes fuel and food components, has been slower to pace despite the recovery in growth.

Several factors were cited by Goyal to explain the deceleration in core inflation. Firstly, the absence of second-round effects on wages from previous commodity price shocks, attributed to slack in Indian labor markets. Secondly, the combination of falling costs and increased sales has led to higher profits for firms, even with subdued demand. Additionally, some companies have reversed earlier price hikes that reflected higher costs.

Anticipating a convergence of core inflation towards 4 percent and stable headline inflation, Goyal raised a red flag on the potential rise in real interest rates. She cautioned that if inflation sustainsably approaches 4 percent by mid-2024, unaddressed, real rates could become excessively high, citing the example of 2018 when a policy repo rate of 6.5 percent and tight liquidity led to severe deflationary consequences.

Echoing Goyal’s concerns, Jayanth Varma emphasized the need for calibrated policy measures to moderate real interest rates. He pointed out that as inflation drops below the upper tolerance band and is projected to average below 4.75 percent in the coming quarters, the current money market interest rates at 6.75 percent yield a high real interest rate of over 2 percent. Varma argued that maintaining a real interest rate slightly below 1.5 percent, based on projected inflation 3-5 quarters ahead, would be optimal.

However, other MPC members maintained the focus on bringing down inflation. RBI Governor Shaktikanta Das expressed caution, highlighting the projected inflation of 4.7 percent one year from now, which is perilously close to 5 percent. He emphasized the need for an actively disinflationary monetary policy in the current circumstances, deeming any shift in policy stance as premature and risky.

As India navigates the intricate interplay between inflation, economic growth, and real interest rates, the MPC’s deliberations underscore the challenges and complexities faced in steering the country’s monetary policy toward stability and sustainability.

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