Food or Fed: What will RBI choose in October?

Food or Fed: That will be the question facing India’s monetary policy committee (MPC) in October. On one hand, elevated food inflation—and its associated risks—have kept the rate-setting panel on alert mode; on the other, the US Federal Reserve has started an era of monetary policy easing with an outsized cut of 50 basis points (bps) last week (and indicated more cuts adding up to 150bps by the end of 2025).

After higher interest rates for over a year, this Fed cut marked the first reduction since the pandemic in 2020, as weak labour market conditions, possible risks of a recession and easing inflation called for policy easing. However, the size of the cut surprised the world: The Fed has delivered half-a-percentage-point cuts mostly in times of crisis, such as the covid outbreak, the 2007 global financial crisis, and the 2001 dot-com bust.

Traditionally, the Fed’s decision sets the tone for monetary policies around the world. There were synchronized rate cuts, pauses, and hikes between 2020 and 2022 as the world first battled economic disruptions and then rapid rise in prices. However, central banks began falling out of sync in 2023, as the Fed insisted on a “higher-for-longer” regime and countries prioritized their domestic conditions.

India has taken the same path, with Reserve Bank of India (RBI) governor Shaktikanta Das insisting earlier this month that some central banks “naturally and justifiably remain averse to premature loosening of policy before inflation has been durably reined in their countries”.

Behind the curve?

The Fed delivered the rate cut against the backdrop of a possible recession, but its chairperson, Jerome Powell, insisted it was done to avoid falling “behind the curve”, as it had in 2022, when it ignored burgeoning inflation as “transitory” for long.

“This start to the easing cycle (by the US) provides some space to emerging markets to kickstart theirs too, but with low global volatility thus far, the RBI is likely to remain focused on domestic dynamics, with a first rate cut by December,” said Madhavi Arora, chief economist, Emkay Global Financial Services. The RBI has kept interest rates unchanged since February 2023.

Beyond monetary policy, the RBI may also choose to “neutralize any knee-jerk impact of the Fed move on the rupee by intervening in the forex market, by purchasing more dollars”, said Vivek Kumar, an economist at QuantEco Research. (Lower interest rates in the US pull the rupee up against the dollar.)

While a majority of the MPC members are focused on a clearer trend of inflation coming down towards the medium-term aim of 4% (and hence holding interest rates), two of the three external members—Jayanth Varma and Ashima Goyal—had warned of the risks of not cutting interest rates and voted for a 25bps cut in their August meeting itself.

Cautious calls

Interestingly, external members’ term ends before the next policy meeting in early October. Unless their tenure gets extended, the rate-setting decision could well be taken by a newly composed MPC.

Dhiraj Nim, economist at ANZ, said a cautious approach—continuing to hold interest rates—will not put the RBI behind the curve as stable inflation is also an important pillar of medium-term growth.

That’s crucial because in 2022, the RBI, too, underestimated the post-covid inflationary pressures, which eventually kept inflation above the 6% upper limit for three consecutive quarters. To date, inflation continues to come in above the RBI’s projections, a trend since 2019-20. Even if inflation aligns with the RBI’s projection in 2024-25, it would still be 50bps higher than the ideal 4% mark. For now, that could lend credence to a possible status quo in interest rates until signals of cooling get clearer by the end of the year.

Pragya Srivastava has contributed to this story.