Members of India's Monetary Policy Committee Maintain Hopes For A Rate Cut

The Monetary Policy Committee (MPC) in India has made the decision to strengthen their 4 per cent retail inflation target, as inflation has returned to the more comfortable range of 2 per cent to 6 per cent. However, this move does not necessarily indicate that interest rates will remain elevated for an extended period, according to two external members of the committee who spoke with Reuters.

Over the past year, India's inflation rate exceeded the 6 per cent upper limit set by the panel in five of the last 12 months but remained within the 4 per cent to 6 per cent range for the other seven months. It even decreased to 5 per cent in September following two months of inflation spikes driven by food costs.

Jayanth Varma, a panel member, explained that the initial urgency to bring inflation within the tolerance band is now behind them, except for a few temporary spikes. Consequently, the focus naturally shifts to achieving the ultimate inflation goal of 4 per cent.

While the MPC, which comprises six members including three external ones, has kept interest rates steady this month and signaled a commitment to the 4 per cent inflation target, it does not necessarily imply a long-term commitment to higher rates. The decisions will remain dependent on economic data, as stated by panel member Ashima Goyal.

Goyal pointed out that despite recurrent supply shocks, core inflation is moving closer to the 4 per cent mark. Varma added that a real interest rate, adjusted for inflation, of about 1 per cent will help sustainably lower inflation to the target level. As projected inflation declines, the nominal repo rate, consistent with a 1 per cent real interest rate, will also decrease. The future direction of interest rates will depend on how inflation projections for the next 3-4 quarters evolve.

The MPC's cautious approach to reaching the inflation target is primarily driven by concerns about the fragility of economic growth, as expressed by Varma. This caution is partly due to the fall in household savings in India, which reached a 50-year low of 5.1 per cent of GDP, as leverage increased.

In the minutes of the MPC meeting, Goyal suggested considering measures such as higher capital requirements for rapidly growing loan categories to prevent excessive exuberance during good times and avoid a financial crash. She also noted that while household leverage needs to increase, it should do so at a moderate pace.