Is Reserve Bank of India behind the curve in lowering the interest rates? The US Fed lowered the federal funds target range by a quarter percentage point (4.5 per cent to 4.75 per cent) in November 2024. This was preceded by the European Central Bank’s 25 basis points rate cut in October, 2024. While Trump’s presidency might put a dampener on the US dovish momentum, the accommodative headwinds from these central banks are consistent.

However, the RBI has remained reluctant to jump on to the dovish spree; and this, at a time when Federal Reserve is not only cutting rates but also sending signals of recalibrating the interest rates to a lower policy rate environment. On October 19, the RBI Governor, Shaktikanta Das, said “…Certainly, we are not behind the curve”, iterating that cutting the policy rate “at this juncture” could be “very premature”.

Now with the GDP growth slowing to a seven-quarter low of 5.4 per cent (Q2 FY 2024-25), and inflation figures still worrying, all eyes are on the December monetary policy decision of the RBI. Is the decision to not cut rates till date justified? Is inflation dampened enough now to cut rates?

CPI Inflation and hawkish stance

Charts 1 and 2 show the inflation data for ‘General Index’ and ‘Food and Beverages Index’, with the rate hike phase (hawkish period) of RBI monetary policy shaded. We can see that while the General Index inflation has declined post the hawkish stance (barring June-August 2023), food inflation shows a subdued response.

For both series, we see a pointed increase after September 2024. Moreover, since July 2023, rural inflation (General Index) is higher compared to urban and ‘combined’ inflation, which is concerning. The inflation numbers lend support to RBI’s decision to not cut rates till date.

Probing Inflationary expectations data

While median inflationary expectation has eased in the recent past, it does not give a complete story of the household’s anticipation of inflation. The median inflationary expectations numbers are based on quantitative responses of the Inflation Expectation Survey of Households (IEHS).

IEHS, conducted by Reserve Bank of India, is a bi-monthly survey of household across 19 cities in India. The survey gathers both qualitative and quantitative responses, collected over different time horizons and commodity groups, making it a rich source of data on the household anticipation of inflation. To understand why tracking the quantitative inflation estimates alone may not be sufficient, we look at the design of the qualitative and quantitative survey questions of IEHS.

Table 1 gives one example each of a qualitative and quantitative question and the possible responses for each. Questions on “Expectations”, as exemplified by survey question 1, have five possible responses (column 2). However, for questions on ‘Views on inflation’ (survey question 2), the range of possible answers is wide. For example, in the July 2024 survey, the question “View on 3 Months ahead Inflation Rate” elicited responses ranging from ‘less than 1%’ to ‘92%’.

The presence of extreme values like this can make the quantitative estimates unreliable. Opting for median values addresses the variation issue, but also removes the inflationary experience of respondents who have reported the extreme values. This means, along with quantitative responses, it is pertinent to consider closely the qualitative responses on expectations.

Considering the qualitative responses from IEHS gives a better idea of directional movement of inflation expectation amongst households. Chart 3 presents the data for ‘Expectations on prices in next 3 months [General]’: the percentage of respondents expecting price increase to be more than the current rate (PINF) has been increasing from November 2023, with a slight fall since March 2024.

The percentage of respondents who do not expect inflation (last three responses to question 1 in Table 1) (PNINF) is largely consistent, while percentage expecting price increase to be same as current rate (PCONS) has increased recently. Defining Balance as the difference PINF and PNINF (broadly in tune with literature), we can see Balance continues to be high.

Chart 4 shows that for food inflation, the percentage of respondents expecting ‘price increase to be greater than current rate’ has gone up sharply as has the “balance’ statistic. The uptick on food inflation is a caution for an inflation sensitive nation like India with likely impact on wage costs and expenditures. Chart 5 shows the percentage of respondents expecting ‘food price rise to be more than current rate’ to be increasing both for one-year and three-month time frame. Inflation expectations regarding food are persistent in the minds of the people.

Why are inflationary expectations important?

Inflationary expectations are the households ‘anticipated’ inflation trajectory for the future and influences their economic decisions. Globally, central banks not only factor in inflationary expectations in interest rate policy decisions but are concerned about ‘anchoring’ of inflationary expectations. The data on inflation iterates what the RBI governor has said: concerns about inflation remain. Moreover, the persistent nature of food inflation is worrying.

Given the inflationary situation, the decision to hold on to the rate cut by RBI was expected. Moreover, in view of the dovish signals from Fed and ECB, RBI’s decision clearly signalled prioritising of the domestic situation over global monetary policy synchronicity: the need of the hour. Will there be a change now given the growth numbers? In the absence of an established empirical linkage between rate cuts and growth, together with the evidence of negative impact of inflation on growth, the decision on the policy rate needs to be taken with caution.

The writer is Associate Professor at National Institute of Bank Management, Pune. Views are personal