Relative to the high FY24 growth, FY25 real activity is expected to have slowed. One quarter’s very low GDP growth print is not representative. However, the momentum of activity has slowed, including the recently released GDP prints for Q3FY25. Forecasts by the RBI and economists suggest a mid-6 percent growth for FY26. There is a cyclical component in this slowdown, but my own sense, reinforced by the analysis of the Economic Survey and other official documents, is that structural impediments have now begun to constrain growth from shifting up to 7 percent-plus levels.
Consumer confidence in RBI Surveys has indeed remained relatively subdued over FY25 in terms of the current situation, but future sentiment has remained more optimistic. These reflect the recent slowdown in economic momentum. The manufacturing sector is the proximate reason for this slowdown, as data shows. There are multiple reasons for this, which are well documented, spanning domestic consumption and investment, as well as exports.
The government has initiated multiple measures to mitigate and reverse this loss of momentum, including a large fiscal demand stimulus, supplemented by monetary policy easing and liquidity infusion by the RBI. These will get gradual traction, even as the more structural impediments are addressed by the central and state governments.
Q. Have spillover effects of global risks increased, given the rise of protectionist policies, disruptions in trade linkages and the uncertainty around global central banks’ responses?The US Fed did emphasise that the disinflation trajectory was slower and that it would be cautious about rate cuts.
Risks of significant spillovers into India of global macro-financial shocks and policy responses have undoubtedly increased. Fortunately, India has sufficiently strong bulwarks in terms of domestic economic resilience, fiscal buffers and other policy headroom to counter extreme volatility, but the extent of expected magnitudes of disruptions, especially via trade linkages, is likely to have some adverse effects, adding to the domestic structural frictions.
Q. There is an expectation that prices will rise over the next year. You said you are cautiously optimistic about the downward trajectory of inflation. How strong are the upward risks to inflation? More so because the IMD recently issued a heatwave warning.
Enterprise surveys expect a rise in input costs over the next year, but their diffusion into output prices is less certain. Both the RBI and the Survey of Professional Forecasters median forecasts for much of FY26 show a gradual reduction in year-on-year headline inflation. Yes, there are risks, but the recent RBI study I have quoted suggests a moderate impact of the imported inflation risks, even if they were to materialise.
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Q. In light of global volatility and a fair degree of uncertainty, how concerned are you about the impact of policy easing on currency volatility and its impact on inflation and growth?
Among these risks, the adverse effects of heightened future currency volatility and the spillovers of the resultant uncertainty onto domestic financial conditions is factored into the economic forecasts underlying monetary policy decisions. The modelled effects of all uncertainties, combined, on forecasts of key economic variables are built into the statistical “confidence intervals” [bands] around the paths of the baseline forecasts. These [potential error] bands are shown in the “fan charts” released in the policy statements.
Specifically on higher exchange volatility, the recent episode was dominantly due to the strength of the US dollar, against all global majors and emerging markets currencies. Each episode of high volatility has specific underlying characteristics, making it difficult to predict outcomes. The underlying macro-financial environment of this episode is marked by significant domestic economic resilience.
Hence, given the totality of these considerations, I remain cautiously optimistic.
Q. How have you factored in the transmission effects of the 25-basis points repo rate cut in terms of boosting consumption and spurring investment? The RBI is on the front foot but there are signs of potential stress in funding availability. How concerned are you about the ongoing liquidity pressure in the system?
Yes, the evolving transmission of the first repo rate cut has been factored in. First, the repo rate cut will pass through into EBLR [External Benchmark Lending Rate]-linked loan rates relatively quickly. These rates apply to MSME loans and much of the retail portfolio. These are likely to be reinforced by a gradual reduction in MCLR [Marginal Cost of Funds based Lending Rate]-linked loans following the significant liquidity being injected by the RBI. Together, this will gradually begin to reduce the whole range of lending rates.
Q. Retail credit was seen as one of the key factors driving consumption and participation of retail investors in markets. Has this wave of consumer spending and retail investing ebbed? Will it weaken discretionary spending?
The monetary policy easing, infusion of liquidity and partial relaxation of the earlier macro-prudential tightening are all designed to increase the flow of bank and non-bank credit into those segments of economic agents that are likely to support growth, particularly MSMEs. Note that the micro and small enterprises within this segment are likely also a large part of the consuming segment, which is likely to initiate a virtuous feedback loop in supporting demand.
Q. Given the increasing complexity of the global and domestic economic environment, is there a case for ‘Festina Lente’ (make haste slowly) when it comes to policy easing?
Monetary policy, in terms of balancing multiple current and expected future trade-offs, is always forward-looking, and incorporates expectations of economic agents. The complexity of the economic environment has made policy actions across countries data-dependent and my own policy response function incorporates global central bank actions as well as domestic macro-financial conditions.
Q. Which are the key indicators you are closely watching at this point of the economic cycle?
The evolution of the growth-inflation trade-off is obviously the key trend of interest. I monitor the influence of all key economic and financial variables, which directly or indirectly feed into the main growth and inflation metrics. Although both metrics have improved since the Q2 prints, they remain vulnerable to risks emanating from primarily global risks, especially imported inflation. India’s external balance, including trade, needs to be closely tracked.
Saugata Bhattacharya, member of the RBI’s Monetary Policy Committee