MPC must ignore Trump's latest jibe, and stay focused on inflation risks and price stability goals

Economic Times

a day ago

Oh, it's very much undead Nothing is certain except death and taxes,' said Benjamin Franklin. In the post-Trump world, one can add a third: slower growth and higher inflation or stagflation, in economists' lexicon. And possibly a fourth: Trump-induced turbulence, as evidenced by the latest round of tariff hikes announced last week.
In a profession noted for its discontents-'If all the economists were laid end to end, they'd never reach a conclusion,' said George Bernard Shaw-Trump has achieved the near impossible. He's ensured almost complete unanimity among economists on the likely outcome of his chop-and-change policy on tariffs: lower growth, higher inflation.
What explains economist-dominated MPC's decision to tread a different path and take a decidedly one-sided view of how Trump's tariffs will impact India's macro economy? Indian exceptionalism? Market capture? The desire of a relatively newly minted MPC (it has yet to complete a year in office in its present avatar) to respond to a nod-and-a-wink from North Block? 'Core inflation remains subdued, and overall inflation is comfortably below the RBI's 4% target, affording room for the easing cycle to be sustained,' says the finance ministry, crossing the unstated Lakshman rekha between the executive and RBI on interest rate policy in its latest monthly report. More importantly, will it continue down that path at its three-day meet, starting tomorrow? Unlike its peers worldwide, MPC seems to believe that growth will be adversely impacted, but not inflation. So, it has cut the policy repo rate by 100 bps since February 2025, reduced CRR by 100 bps and flooded the system with liquidity. All this, even as central banks in the US, China, the EU and Britain have opted to hold rates constant till there is greater clarity.The fall in inflation to a more than six-year low in June was driven primarily by F&B group, which accounts for close to 46% of the consumption basket/index and can quickly reverse (one extreme weather event is all it takes). The US and Britain have seen an uptick in inflation. Oil prices are likely to move up post-Trump's threat to impose a penalty (100% tariff?) on countries that buy oil from Russia (India is a big buyer). Hardeep Puri has warned that removing Russian supplies from the market could push oil prices to $130-140 a barrel.Meanwhile, the market has been signalling higher rates for some time now, with savers deserting bank deposits for riskier forms of investment, including, yes, cryptos. In its third buyback of this fiscal year, on July 17, RBI accepted only 79% of the notified amount, suggesting market participants wanted higher yields than its comfort level.
Experience has shown that more liquidity may or may not spur credit growth, and hence economic growth. But it will almost definitely spur inflation in a scenario where supply-side factors (disruption of supply chains and higher tariffs worldwide) are likely to shift the balance of risks towards higher inflation, even as our domestic-focused economy navigates these shocks better. No wonder IMF has just hiked its growth projections for India. There is also the attendant risk of banks and NFBCs lending to less creditworthy borrowers. In a conversation with Raghuram Rajan, Jerome Powell, put it well: 'Tariffs are highly likely to generate at least a temporary rise in inflation. The inflationary effects could also be more persistent.'In a speech on economic outlook in April, Powell said: 'Our obligation is to keep longer-term inflation expectations well anchored and to make certain that a one-time increase in the price level does not become an ongoing inflation problem. We may find ourselves in the challenging scenario in which our dual-mandate goals are in tension. If that were to occur, we would consider how far the economy is from each goal, and the potentially different time horizons over which those respective gaps would be anticipated to close.'To assume, as Sanjay Malhotra seems to have done, 'Inflation is under control, and we can assume that we have won the war...growth is good, but there is still room for improvement,' is unwise. RBI's mandate under the inflation targeting regime is clear. It is 'price stability, keeping in mind the objective of growth'. It is not a dual objective, as in the case of the US Fed. In terms of priorities, inflation ranks first. It is most certainly not 'aspirational' growth, a term that has newly entered MPC's lexicon.We might have won the battle against inflation, thanks in part to statistical sleight of hand (base effects) but not the war. Fortunately, RBI governor seems to have realised he might have erred. Last month, Malhotra's statement that 'though the RBI has won the battle against inflation, it continues its war against price rise, keeping in mind its objective of price stability', is a notable shift. One that suggests he, and MPC, will not rush in with another hasty rate cut. Never mind what Trump says, or the market wants. (Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.) Elevate your knowledge and leadership skills at a cost cheaper than your daily tea. Zomato delivered, but did the other listed unicorns?
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