Why the RBI can’t afford cheap money
The argument for cheap money usually rests on growth support. But India’s current recovery is not being powered by strong income growth or healthy private capex | Photo Credit: vkbhat The RBI’s latest policy decision to hold the repo rate at 5.25 per cent was unsurprising. What is more important is the message embedded in the pause: the central bank appears increasingly comfortable with a growth-inflation balance that, on closer inspection, is far less stable than it looks. The FY27 GDP growth forecast was nudged up to 6.7 per cent from 6.6 per cent, while the CPI inflation forecast was trimmed marginally to 5 per cent from 5.1 per cent. The market may read that as reassurance. It should not. At face value, the RBI is betting that India’s growth remains resilient enough to withstand external shocks, while inflation stays tame enough to avoid urgency. But this confidence rests on a fragile reading of the data. Wholesale inflation is running hot, crude remains elevated, geopolitical risks are alive, and global trade tensions are intensifying. Yet retail inflation has not reacted as sharply as expected. That may sound like a policy success. It may also be a warning sign that demand is weaker than the headline numbers suggest. This is where the story becomes uncomfortable. If growth were truly strong and broad-based, higher input costs would eventually pass through to consumers. They are not. WPI inflation in Q1 FY27 stood at 9.3 per cent, but CPI has hovered around 4 per cent, with the actual quarterly print below the RBI’s own projection. The obvious explanation is that firms are absorbing costs because consumer demand is not strong enough to support price hikes. In other words, inflation is not low because the economy is healthy. It may be low because demand is not as robust as it appears. The consumption picture points in the same direction. Rural wages are weak in real terms, formal-sector compensation is barely keeping pace with inflation, and household surveys continue to suggest that the consumer base is more fragile than official growth numbers imply. Where demand exists, it is narrow, urban, and concentrated in pockets such as autos, helped in part by GST rationalisation. That is not a picture of a broad consumption revival. It is a picture of selective spending, supported increasingly by leverage. The production data reinforce this view. Durable goods have shown some momentum, but non-durables remain flat. Only a minority of sectors — autos, electrical goods, computers, textiles — are showing meaningful strength, while the rest lag behind. Corporate results tell the same tale: raw material costs are rising faster than pricing power, and margins are being squeezed. That is not what one would expect if demand were genuinely buoyant. The RBI seems to be assuming that current weakness in inflation will persist because the economy can sustain it. That assumption is dangerous. The Bank’s own urban inflation expectations survey suggests experienced inflation is far higher than the official CPI reading. If households feel inflation closer to 8 per cent than 4 per cent, then the real economy is already operating under a very different set of conditions than policy models imply. The rural economy adds another layer of concern. The RBI treats rural weakness as a prospective risk, likely to emerge if El Niño hits agricultural output. But the evidence suggests the weakness is already here. Non-durable consumption is flat, housing demand is soft, and the growth that does exist is concentrated in durables such as two-wheelers and four-wheelers, often financed by credit rather than income growth. That is not a sign of resilience. It is a sign of strain. The external environment makes cheap money even harder to justify. Global yields are moving higher. The US 10-year is near 4.7 per cent, and Japan’s 10-year has climbed to levels not seen in decades. At the same time, India’s trade deficit remains wide, widening to $86.6 billion in Q1 FY27 — nearly 10 per cent of GDP. If export gains are being driven more by commodity prices than by real volume growth, then the external balance is weaker than it appears. This is why the case for a negative real policy rate is unconvincing. Average inflation over the next few quarters is expected to remain around 5.6 per cent, peaking at 5.9 per cent in Q3 FY27. Against a repo rate of 5.25 per cent, that means the real rate is effectively negative. For an emerging economy, that is not a sign of prudence. It is a sign of policy distortion. A real rate of at least 1 per cent is the minimum consistent with price stability and financial discipline. On that basis, the nominal repo rate should be closer to 6.5 per cent. If the goal is a healthier 2 per cent real rate, it should be even higher. The argument for cheap money usually rests on growth support. But India’s current recovery is not being powered by strong income growth or healthy private capex. It is being sustained by household leverage, urban pockets of consumption, and imported capital, which is now relapsing on to exigent NRI deposit mobilisation at higher interest rate. Real household incomes are rising only modestly. Rural wage growth remains weak. Household debt is already high. The result is a K-shaped recovery that benefits those already spending and leaves the broader base behind. Cheap money, in this context, is not a growth strategy. It is a postponement strategy. It delays the necessary adjustment, encourages leveraged consumption, weakens savings, and worsens external vulnerability. It also leaves the RBI with less room to respond when inflation eventually becomes harder to ignore.