Interest rate cut at this stage will be ‘very premature, very risky’: RBI Governor Das

Earlier this month, the RBI’s newly reconstituted Monetary Policy Committee (MPC) left the repo rate – the key policy rate – steady at 6.5 per cent for 20 consecutive months as inflation continues to remain a sore point.

At a time when consumer price-based inflation (CPI) is expected to remain above 5 per cent, and growth holding on, a cut in the interest rate would be “premature, and very risky”, Reserve Bank of India (RBI) Governor Shaktikanta Das said recently.

• Retail inflation, which surged to a nine-month high of 49 per cent in September from 3.65 per cent in August, is expected to remain elevated in October before moderating in November, Das said in a fireside chat at the India Credit Forum hosted by Bloomberg.
• “I would like to say that certainly, we are not behind the curve. The Indian growth story remains intact. India is poised to grow at 2 per cent according to the projection which we made in the last Monetary Policy Committeemeeting. Growth is holding on, steady and resilient. Inflation is moderating with certain risks about which we have to be very vigilant,” he said.
• “A rate cut at this stage will be very premature and can be very risky. When your inflation is 5 per cent and the next (inflation) print is also expected to be high, you can’t be cutting rates at that point, more so when your growth is also doing well,” he said.
• Earlier this month, the RBI’s newly reconstituted MPC left the repo rate — the key policy rate — steady at 5 per cent for 20 consecutive months as inflation continued to remain a sore point. The six-member MPC, however, changed the monetary policy stance to ‘neutral’, after keeping it as ‘withdrawal of accommodation’ for 28 straight months.

What is withdrawal of accommodation?

In economics, “withdrawal of accommodation” refers to the gradual reduction or removal of monetary policy measures that were previously implemented to stimulate economic growth, typically during periods of economic slowdown or crisis. These accommodative measures usually involve lowering interest rates or increasing the money supply to encourage borrowing, spending, and investment.

Key Concepts:

1. Monetary Accommodation: When central banks adopt accommodative monetary policies, they aim to make financial conditions more favorable for economic growth. This often involves:
   • Lowering interest rates to reduce the cost of borrowing.
   • Injecting liquidity into the economy through quantitative easing (buying government securities or other financial assets).
   • Other forms of stimulus to support the economy.
2. Withdrawal of Accommodation: This process involves scaling back these supportive measures as the economy shows signs of recovery, to prevent overheating, high inflation, or excessive financial risk-taking. Common steps in withdrawing accommodation include:
   • Raising interest rates to curb inflationary pressures and slow down excessive borrowing.
   • Reducing the central bank’s balance sheet by selling off previously purchased securities or stopping new purchases (quantitative tightening).

Example:

• During the COVID-19 pandemic, many central banks, including the U.S. Federal Reserve and the Reserve Bank of India (RBI), adopted accommodative policies by lowering interest rates and injecting liquidity into the economy to support growth. As economies recovered, these central banks began the withdrawal of accommodation by gradually increasing interest rates (often called “rate hikes”) to prevent inflation from rising too high.

Why is it Important?

• Inflation Control: Withdrawal of accommodation is crucial to prevent inflation from spiraling out of control, which can erode purchasing power and destabilize the economy.
• Financial Stability: Prolonged accommodative policies may lead to excessive risk-taking, asset bubbles, or debt accumulation. Withdrawing accommodation helps to normalize financial conditions.
• Sustainable Growth: By removing stimulus as the economy strengthens, central banks aim to achieve a balanced, sustainable growth trajectory without excessive overheating.

Recent Example:

In 2022-2023, many central banks worldwide, including the U.S. Federal Reserve and the European Central Bank, initiated the withdrawal of accommodation by raising interest rates and reducing their balance sheets to combat high inflation, which had spiked due to supply chain disruptions, post-pandemic demand, and geopolitical factors like the Russia-Ukraine conflict.