RBI has done well to focus on its core competence: Price stability

In times of extreme uncertainty, as at present, it is better to mark time. Wait for the tariff-induced fog to clear and then proceed. Hence, its unanimous decision to maintain status quo on the policy rate (5.5%) and keep its monetary policy stance ‘neutral.’

This is welcome. Though the minutes of the last MPC meet in June had hinted as much—“After having reduced the policy repo rate by 100 bps in quick succession since February 2025, under the current circumstances, monetary policy is left with very limited space to support growth”—many in the market expected to see another rate cut.

The reason is that the MPC under Governor Sanjay Malhotra has shown a marked bias in favour of growth in the inflation-growth trade-off. It has cut rates at three successive meetings (in February, April and June 2025), with its June meet smacking almost of adventurism—a 50 basis points (bps) reduction in the repo rate and a reduction in the cash reserve ratio by 100 bps!

It is good, therefore, that the MPC seems to have tacitly accepted that there are limits to what monetary policy can do. As Governor Malhotra admitted at the press conference later in the day, “It is difficult to predict the impact of tariffs.” All the more reason for the MPC to bide its time before rushing in with more pre-emptive rate cuts.

To give an analogy from the world of cricket, David Frith, English cricket writer and historian, once said, “Test cricket is the only sport where doing nothing—leaving the ball—is sometimes the most intelligent act. It is only here that restraint can be heroic.”

That statement is particularly apt in view of the MPC’s restraint (its status quo decision) when, contrarily, in the eyes of most observers, it has reduced its inflation projection for 2025-26 from 3.7% in June to 3.1% now.

Front-loading of rate action is not always the best option. Even if there is a growth slowdown, which there isn’t—the MPC’s own projection for 2025-26 remains at 6.5% and, surprise, surprise, is higher at 6.6% for the next fiscal year—a slowdown occasioned by tariff hikes and global uncertainty cannot be tackled by monetary policy.

On the contrary! The remedy, if any, lies squarely within the domain of fiscal policy. Governments can talk of ‘aspirational’ growth; not central banks. The latter may, at best, focus on ‘potential’ growth, though even that is a somewhat abstruse number. Central banks must be guided by reliable data.

Indeed, many would argue there is a danger that monetary policy may already have over-reached itself. Aggressive rate cuts have adversely impacted household financial savings, even as credit offtake remains lacklustre.

The argument that overall credit to the corporate sector has increased does not cut any ice.

RBI’s signalling mechanism is primarily intended for banks. So if bank credit has not picked up, but has in fact fallen, chances are that lower interest rates have not served their intended purpose: higher credit offtake and faster growth.

The role of monetary policy is, in any case, very limited if the reason for muted credit growth is structural, rather than cyclical.

In the absence of corporate demand for credit, there is also the very real danger that banks may use easy money to expand their retail portfolios and lend to sub-prime borrowers, threatening financial stability.

At the same time, benign inflation numbers— retail inflation was at a 77-month low of 2.1% in June—can be quite misleading; the consequence of a high base (high inflation in the comparable period last year) and low inflation in the volatile food-and-beverages category that accounts for more than 40% of the consumer price index.

Yet the MPC’s June resolution was silent on the role of the base effect in keeping inflation numbers low.

The August resolution makes amends for this lapse. There is an explicit mention of base effects. “CPI inflation, however, is likely to edge up above 4 per cent by Q4:2025-26 and beyond, as unfavourable base effects, and demand side factors from policy actions come into play.”

As the governor admits, “Core inflation has been rising steadily from the recent low of 3.6 per cent recorded during December-January 2024-25 and averaged 4.3 per cent in Q1 this year.’

With the rupee likely to depreciate further (it fell to a new closing low of ₹87.8 against the dollar on Tuesday), thanks to escalating trade tensions with the US and President Donald Trump’s threat to levy penalties on India for buying Russian oil and arms, the pass-through to retail inflation from higher import prices, including oil, cannot be ignored.

Monetary policy, we all know, must be forward-looking. At the same time, caution, rather than adventurism, is the hallmark of wise central banks. RBI’s MPC has done well to return to form.

The author is a senior journalist and a former central banker.