RBI’s MPC faces global uncertainty, weighing inflation targets against financial instability risks

Parliament’s mandate for the Reserve Bank of India‘s Monetary Policy Committee is to target inflation at 4%, with growth in mind. But US President Donald Trump has put something else on its table: Financial instability.A cut in repo rate, the rate at which the central bank lends to banks, has been delivered with a quarter point reduction to 6.25%, thanks to the fiscal room. The magnitude or the lack of it raises questions about the future path of cost of funds.

An MPC confident of downward inflation trajectory and the necessity to support economic growth probably might have delivered half a point cut and a shift in monetary stance. But the neutral stance shows it’s a cut without conviction amid global uncertainty.

“Higher worry for us would be the global uncertainties and how it pans out,” governor Sanjay Malhotra said at the press conference after the MPC decision. “Even if the tariff trade wars were to not pan out, but just the uncertainty in itself is worrisome because that has a direct impact on growth, investment decisions and consumption expenditure.”

To be sure, the MPC isn’t alone in grappling with the fallout of a new world order. Even the Federal Reserve’s Jerome Powell is figuring out what his political boss is up to which is not quite easy. Governor Malhotra was quite candid.

President Trump has introduced this uncertainty with economic models yet to be designed to factor in his contradicting actions in a span of hours, or for that matter how countries facing tariffs would react and rework their trade tactics. If plentiful monsoons and the government’s actions alone were to impact inflation, the MPC would certainly have been comfortable in proposing half a point reduction in rates. But that is not the case.Governor Malhotra pointed out to imported inflation – that’s exactly what’s keeping the Fed chair Powell in check. The US market is not only factoring in lesser reduction in Fed funds rate, but some are even working on the assumption that there could be a U-turn.Imported inflation for India has been through crude oil. But even that dynamic has undergone a shift with Trump’s ‘drill baby drill’ policy on increasing energy production working in India’s favour.

Global trade staring at dysfunction has put financial markets on the edge. Currencies are swooning. Yields are soaring.

Indian Rupee is no exception. It is sliding to a new low every day. There’s unlikely to be any relief on that front in the near future reducing MPC’s manoeuvrability.

“Risk to inflation-growth outlook stems from excessive volatility in global financial markets, potential tariff wars and weather uncertainties,” said Gaura Sen Gupta, economist at IDFC First Bank. “The rate cut cycle is expected to be shallow, given the depreciation pressure on the INR.”

Capital flows, which in normal times are taken for granted with consumers and investors often splurging like drunken sailors, can come to a sudden stop. When that happens, the only weapon to attract funds or temper the capital flight is interest rates, which the RBI doesn’t want to blunt by sharp reductions. While growth and inflation dominate the popular narrative, for the monetary policy maker, stability takes precedence over the rest as it could undermine the very growth that everyone aspires for.