While inflation has been steadily declining, the RBI opted to retain its ‘neutral’ stance, signaling a measured approach rather than give push to boost liquidity and demand

On February 7, 2025, the Reserve Bank of India (RBI) Governor Sanjay Malhotra announced the decisions taken by the six-member Monetary Policy Committee (MPC) in its sixth bi-monthly meeting of the current financial year (FY). It has reduced the policy rate or the repo rate (the interest rate at which the RBI lends to banks) by 25 basis points to 6.25 per cent. This marks the first repo rate cut in nearly five years. Moreover, it has continued with a neutral stance which it shifted in its fourth bi-monthly review/announcement on October 10, 2024, from its earlier stance of “withdrawal of accommodation”.  In 2016, the Union Government put in place an institutionalized framework to enable the MPC to formulate monetary policy and determine the key interest rates including the policy rate for inflation targeting. It mandated the RBI to fix the policy rate in such a manner as to maintain the Consumer Price Index or CPI (it corresponds to a basket that includes food, fuel, manufactured goods, and select services) within the target range of 4 per cent (+/- 2 per cent).

The RBI decides the policy rates once in two months during each FY.  The mandate initially given for five years ending March 31, 2021, has since been extended for a further period of five years. The current mandate will continue till March 31, 2026.  The other crucial policy instrument the RBI uses for targeting inflation is Liquidity - jargon for the quantum of credit available in the banking system. Pumping more liquidity along with a reduction in the policy rate represents a scenario which in jargon is described as an ‘accommodative’ policy stance. The terminology was coined by the outgoing governor Shaktikanta Das in June 2019 when he started going for aggressive cuts in the policy rate and an increase in credit availability.

Since June 2022 the RBI changed its stance to “withdrawal of accommodation” and had stuck to it till October 9, 2024, when in the fourth bi-monthly review, the MPC decided to go for a “neutral” stance. A “neutral” stance connotes that the RBI has vowed to keep its options flexible meaning it will neither squeeze liquidity by restricting credit availability and keeping policy rates high nor go for unrestrained lending at low interest rates. 

While inflation targeting is important, it is equally necessary to dovetail the monetary policy to sustain the momentum of high growth. During the second quarter of the current FY, growth in GDP plummeted to a low of 5.4 per cent down from a high of 8.1 per cent during the second Qr of FY 2023-24.

For the current FY 2024-25, it is estimated at 6.4 percent as against 8.2 percent recorded during FY 2023-24. Seen in this backdrop and an overarching need to achieve a growth of 8 per cent on a sustained basis in line to make India a ‘developed economy’ by 2047, the RBI could have given the desired push.              It could have gone for an ‘accommodative’ policy stance by opting for a significant cut in the policy rate and pumping sufficient cash into the banking system. However, it has stuck to a “neutral” stance while reducing the repo rate by a small 0.25 per cent.RBI’s reluctance has to do with a mindset that was reflected in ex-Governor Das’s observation while announcing the first bi-monthly policy of the current FY. He had said “The elephant has now gone out for a walk and appears to be returning to the forest.

We would like the elephant to return to the forest and remain there on a durable basis.” Put simply, he meant there was no need to start reducing interest rates until inflation reached the target of 4 per cent and stayed at that level. The incumbent Governor has continued with this mindset. In February 2023, the policy rate was at a peak of 6.5 per cent. During FY 2022-23, the CPI inflation was hovering around 8 percent. In the following year, it started decreasing from 7.4 per cent in July 2023 to 5 per cent in September 2023, 4.8 per cent in October 2023 and 5.1 per cent during January/February 2024. For FY 2023-24, it was 5.4 percent. During the current FY also, it has kept low; 5.08 percent in June 2024 and 3.54 percent in July of 2024. After a brief spurt of 6.2 per cent in October 2024, in January 2025, it declined to 4.3 per cent.

During FY 2024-25, the RBI has estimated it at 4.8 percent. Given the above, from the third quarter of FY 2023-24, the CPI inflation has remained well within the target range of 4 per cent (+/- 2 per cent). This position continues during the current FY. For FY 2025-26, the RBI expects it to be 4.2 per cent. Thus, there was a strong case for a significant reduction in the repo rate besides the injection of sufficient liquidity. This would have helped in stimulating demand thereby giving a boost to economic growth besides helping millions of borrowers reduce their EMIs and helping industries, especially MSMEs reduce the cost of servicing their loans. But, this was not to be.

The problem is RBI’s obsession with inflation. Malhotra recognizes that inflation is on a downward trajectory. Yet, he doesn’t want to relinquish his neutral stance citing global economic challenges “progress in global disinflation is stalling.”

Put simply, he fears imported inflation impacting CPI hence, a “neutral stance will provide MPC flexibility to respond to evolving macroeconomic environment.” A major factor contributing to wide variations in CPI inflation is food inflation which has a weight of around 40 per cent and is impacted predominantly by supply side/seasonal factors whereas monetary policy instruments work on the demand side. Invariably, food inflation maintains an upward trend even as a small disruption in supply caused by seasonal factors can lead to spiralling prices. 

As long as food remains a part of the CPI basket, inflation targeting will always remain a problem. There is an urgent need to exclude it while setting benchmark interest rates, an idea that was mooted by the Chief Economic Advisor in the Economic Survey (ES) for 2023-24. The CEA argued that monetary policy has no bearing on the prices of food items, which are dictated by supply-side pressures.

For instance, during 2021-22, wheat output was affected by unusually high temperatures. During 2022-23, rains accompanied by hailstorms acted as a spoiler. During the first half of FY 2023-24, food inflation went up due to a spike in the prices of vegetables caused by seasonal factors. The spurt in food prices during October 2024 also had to do with supply-side pressures only.

The RBI can achieve little to control them by keeping the policy rate high. The RBI should take the idea mooted in the ES – 2023-24 on board. Meanwhile, it should consider reducing the weight of food inflation in CPI to reflect the contemporary reality. The current 40 per cent weight is based on the Consumption Expenditure Survey (CES) of 2011-12 whereas Summary Statistics from the 2022-23 CES point towards a significant reduction.

While formulating its monetary policy, the RBI’s prime responsibility is to ensure macro-economic stability its pivotal focus being on keeping inflation within reasonable bounds. However, it can’t be oblivious of the dire need to support economic growth which could be adversely impacted if it doesn’t relax the credit environment.

(The writer is a policy analyst; views are personal)