Amidst recessionary trends in the economy and persistently high retail inflation rates, fuelled by food prices, the Reserve Bank of India has acted prudently and avoided “any knee-jerk reactions,” in the words of its Governor Shaktikanta Das. The central bank’s Monetary Policy Committee (MPC) has decided to keep key benchmark interest rates unchanged. In doing so, the RBI has not heeded calls for Repo rate cut from public as well as key figures in the government.

There have been calls from Chief Economic Advisor V Anantha Nageswaran, Commerce Minister Piyush Goyal and the Finance Minister herself, Nirmala Sitharaman for reducing borrowing burden for businesses. The CEA even demanded that food items be taken off retail inflation basket, contending that monetary policy does not impinge on them. However, the central bank feels otherwise. It acted strictly as per its legal mandate, said Das on Friday.

The repo rate is retained at 6.5% for the 10th consecutive time since February 2023. Repo is the rate at which commercial banks borrow money from the central bank.

A lower repo rate brings down the cost of borrowing for them, thereby inducing them to lend more. Though lower rate trigger more spending, and greater economic activity for businesses, it can potentially exacerbate inflationary pressures. A high inflation will eat into purchasing power of consumers, slowing spending on non-essential goods, which could in turn drag down economy growth. Central banks will tend to raise rates to rein in inflation, which can further depress consumer spending, while making borrowing more expensive for both businesses and individuals. This factor seems to weigh on the RBI MPC.

However, taking cognisance of the liquidity tightening in the system, the cash reserve ratio (CRR) - the percentage of cash required to be kept in reserves as against the bank’s total deposits - has been cut by 50 basis points to 4%. This may inject Rs 1.16 lakh crore liquidity into the financial system. Why is there liquidity tightening in the financial system, one may wonder. In the quarter ended June 2024, bank deposits grew at 11.7%, credit expanded by 15%. This wide gap has been seen to be causing asset-liability mismatch at the banks end.

The RBI will now wait for the high food prices to cool before deciding on any rate cut in the future at its next MPC meeting in February. The inflation surged to a 14-month high of 6.21% in October as against the RBI’s upper tolerance band of 6%.

The Q2 GDP figures show that sluggishness is plaguing manufacturing and mining sectors. With the urban demand stagnating, the rural demand is not simply enough to offset the imbalance. Unless, the government takes remedial measures, analysts fear the economy could be heading for a cyclical slowdown. High inflation will deter investments by industrialists and investors. Keep in mind that the inflation forecast has just been revised upward to 4.8% for this fiscal with the likelihood of 4% in the second quarter of FY26.

The RBI’s downward revision of its GDP forecast by 60 basis points to 6.6% points to headwinds for the economy in the second half. As Das said, a growth slowdown – if it lingers beyond a point – may need policy support. Add to the government measures, a healthy rise in agricultural output should ease inflation, facilitating a rate cut in February.

In all, the central bank has taken a decision in the long-term interests of the country, even as it tweaked CRR to address the short term liquidity mismatch. It is heartening that the RBI is alive to the challenges.