Limited impact of Monetary policy on foreign outflows, currency: MPC members

The six-member rate-setting committee had announced a 25 basis points cut in repo rate to 6.25% earlier this month, the first rate reduction in five years.

According to the minutes, MPC member and Reserve Bank of India executive director Rajiv Ranjan said the need to cut rates should not be hindered by concerns of capital outflows due to interest rate differentials.

“Capital flows to India are driven more by its distinctive growth story rather than interest rate differentials, a phenomenon observed for many EMEs (emerging market economies). Reviving growth and building on resilience is an imperative, especially at a country-specific level. Interest rate defence of exchange rate could turn out to be counter-productive, especially during periods of global tide towards outflows driven by factors that do not differentiate across nations such as the risk-taking propensity of global investors or uncertainty driving reserve currency strength," said Ranjan.

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The other MPC member Saugata Bhattacharya also allayed doubts about whether policy easing could result in rupee depreciation. Quoting a study, Bhattacharya said that if rupee depreciates by 5%, consumer price “inflation could be higher by around 35 bps" and GDP growth “could edge up by 25 bps through short-term stimulation of exports".

“A possible repercussion of policy easing might be an increase in currency volatility and a depreciation of the USDINR pair. This might not be a major cause for concern," said Bhattacharya.

The other MPC member Ram Singh corroborated this point, highlighting that capital flows into India were not disrupted despite the benchmark rate differentials between India and the US falling over the last four years.

“For instance, the rate differential with the US has decreased from almost 4% in 2020 to about 1.5% in September 2024 till the US Fed started rate cuts, said Singh. “The increased differentials did not adversely affect inflows of USD, very likely due to strong growth fundamentals," he added.

'Too restrictive'

The three external MPC members, however, said India’s monetary policy may have become too restrictive, resulting in the current growth slowdown. RBI had kept interest rates unchanged since February 2023, determined to bring down inflation to the 4% target. While this did bring down inflation expectations, the central bank had to downgrade its FY25 growth estimates from 7.2% in the October policy to 6.6% in December policy. According to the first advanced GDP estimates from the National Statistical Office (NSO), India may grow at an even lower pace of 6.4% during the year.

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“Subdued private consumption due to a low growth rate of real wages is a factor behind the slowdown. However, excessively contractionary monetary policy has aggravated the problem. High interest rates and regulatory tightening have brought down the credit growth rate," said Singh. “This puts downward pressure on demand growth for several segments of the economy," Singh added.

Bhattacharya, who had described growth slowdown to be transitory in the December minutes, noted the sharp fall in bank credit to the micro and small enterprises segment of MSMEs to 12.1% year on year as of December 2024, compared to 20.3% a year earlier, and in the manufacturing segment, from 14.8% to 9.8%. “This slowing momentum in credit flows to a priority segment – is a matter of concern," he said. In the previous minutes, Bhattacharya had ruled out the impact of interest costs on growth slowdown.

Amid uncertainties

RBI governor Sanjay Malhotra, in his first comments to the MPC, highlighted the increased uncertainties faced by monetary policy.

“Rising uncertainties on global financial markets and trade policy front, coupled with continuing risk of adverse weather events, pose risks to the inflation and growth outlook. We need to be watchful of how these forces play out," said Malhotra.

RBI deputy governor Rajeshwar Rao, who is holding the temporary position of MPC member, also noted that there is now “greater space" for adding growth concerns.

“At the current juncture, with a further alignment of headline inflation towards the 4% target, there is greater space to address concerns regarding growth by way of reduction in the policy repo rate. This monetary policy measure in conjunction with the fiscal measures announced in the Budget should give a fillip to aggregate demand conditions," said Rao.

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That said, economists are expecting another 25 basis points rate cut in April. But they remain divided over the extent of rate cuts required in the next fiscal year, with a few expecting a deep rate cut cycle and the others expecting a shallow rate cut given the global uncertainties.

“The minutes reveal how policy preference has shifted towards managing growth in a unanimous way. Policy making is now understood to be having limited power or impact on the external sector issues, including INR management. Neither INR led inflation hit is appearing to be too threatening, nor is the interest rate defence route being seen as an ideal one to save INR," said Madhavi Arora, chief economist, Emkay Global Financial Services. Arora is expecting another 25-50 basis points cut this year.