The Reserve Bank of India’s surprise policy rate cut on December 6, coming soon after official data showed GDP growth of 8.2 per cent, has sparked debate on whether monetary policy is out of sync with economic reality. At the heart of this decision lies not exuberance, but uncertainty — a challenge created by conflicting economic signals and unreliable macroeconomic indicators.
Why the Rate Cut Appeared Counter-Intuitive
Conventional macroeconomic theory suggests that when an economy grows rapidly, central banks should tighten monetary policy to prevent overheating and inflation. With India reported as the fastest-growing major economy, an interest rate cut seemed puzzling.
However, the inflation backdrop was unusual. Headline inflation was running below 1 per cent, far below the RBI’s medium-term target of 4 per cent. This low-inflation environment created policy space for easing, but it did not automatically justify stimulus when growth was supposedly robust.
GDP Growth Numbers and the Puzzle Beneath
Official GDP estimates showed a sharp acceleration from around 6.5 per cent last year to over 8 per cent, with manufacturing and services both expanding at about 9 per cent. On paper, this suggested a broad-based recovery.
Yet, these numbers are difficult to reconcile with ground-level indicators. Explanations such as GST rate cuts boosting consumption appear weak, since the tax reductions were implemented late in September and could not have significantly influenced July–September growth figures.
Contradictory Signals from High-Frequency Indicators
Other macroeconomic data raise serious doubts about the strength of demand:
- Industrial output grew only about 3 per cent during April–September, the slowest since 2020–21.
- Core sectors like mining, manufacturing, and electricity showed sluggish growth or contraction.
- Non-food bank credit growth slowed to around 10 per cent from 13 per cent a year earlier, indicating weaker investment and consumption demand.
- Gross tax collections rose by just 2.8 per cent, the slowest pace in 15 years, with income tax, corporate tax, and GST all showing low single-digit growth.
These indicators are typically inconsistent with an economy expanding at over 8 per cent.
The Rupee, Capital Flows, and External Anomalies
Another inconsistency lies in external sector behaviour. The rupee depreciated by more than 6 per cent against the US dollar, becoming Asia’s worst-performing currency during the year. This is unusual for a supposedly booming economy.
Despite a modest current account deficit of under 2 per cent of GDP, capital inflows remained weak and even declined after the GDP data release. The inability of a high-growth economy to attract capital underscores doubts about the credibility of headline growth numbers.
Monetary Policy Under Statistical Fog
For the RBI, this uncertainty complicates inflation targeting. Effective monetary policy depends on accurate assessment of demand conditions to forecast future inflation. While central banks often rely on core inflation to filter out food and fuel volatility, even this becomes unreliable if the true state of the economy is unclear.
Faced with this fog, policymakers adopted a risk-management approach. With inflation collapsing, real interest rates were rising, posing a risk of choking demand if the economy was weaker than GDP data suggested. Cutting nominal rates, by contrast, posed little risk to the inflation target given the extremely low price pressures.
Risk-Based Policy Choices and Their Limits
The RBI’s rate cut and the government’s GST reductions were both based on asymmetric risks:
- If demand is weak, inaction could deepen slowdown.
- If demand is strong, policy easing would still not immediately threaten inflation due to the low price base.
However, this approach carries the danger of being proven wrong if demand turns out to be genuinely robust, potentially fuelling future imbalances.
Why Fixing Data Quality Has Become Urgent
Persistent inconsistencies between headline GDP and other indicators have confused financial markets and risk undermining policy credibility. The forthcoming release of updated GDP and CPI series by the National Statistical Office offers hope of improved measurement.
Until macroeconomic data becomes more reliable, both monetary and fiscal policy will remain constrained by uncertainty rather than guided by clarity.
What to Note for Prelims?
- RBI’s inflation targeting framework (4% ±2%).
- Difference between headline inflation and core inflation.
- Concept of real interest rates.
- Role of GDP, IIP, tax collections, and credit growth as economic indicators.
What to Note for Mains?
- Challenges of policymaking under data uncertainty.
- Limits of GDP as a sole indicator of economic health.
- Risk-management approach in monetary policy.
- Link between data credibility, market confidence, and policy effectiveness.
