Economy
Mint Primer: Why it will be a baptism by fire for new RBI Guv
Summary
- The government feels the slowdown is temporary but what should worry the new RBI governor more is the evolving stagflationary scenario—that’s slow growth accompanied by high inflation.
On 11 December, Sanjay Malhotra, a career bureaucrat, took over as the 26th governor of the Reserve Bank of India (RBI). Mint looks at the challenges he will confront as he goes about balancing price stability with economic growth apart from dealing with rupee volatility.
Is it not a good time to be RBI governor?
The economy, which was till recently posting a rapid pace, has slowed suddenly. In the second quarter of 2024-25, the gross domestic product (GDP) grew at 5.4%, the lowest in nearly two years. Just last year, the economy was accelerating with a quarterly GDP growth in excess of 8% (see chart). A sudden drop in urban consumption and a heavy monsoon played a significant part in the slowdown. The government feels the slowdown is temporary but what should worry the new RBI governor more is the evolving stagflationary scenario—that’s slow growth accompanied by high inflation.
Why is stagflation a worry?
Stagflation is a policy nightmare for any central banker. This is because a solution to deal with one problem typically worsens the other. In other words, if the RBI cuts interest rates to boost growth, inflation will start rising further. On the other hand, if the interest rate is maintained at the current level to tackle inflation, economic growth will decline further. Inflation has remained sticky in India. In November, it fell to 5.5% from 6.2% in the preceding month, but this is higher than the central bank’s 4% target. Governor Malhotra will be hoping that the dip in growth is momentary and will revive quickly.
Will he come under pressure to cut rates?
Yes. Even before its previous meeting earlier this month, the Monetary Policy Committee which sets the interest rate came under pressure to do so but resisted as inflation was still high. Instead, it cut the cash reserve ratio for banks, injecting ₹1.16 trillion into the banking system. If the GDP growth does not revive, the pressure on RBI to cut rates will only increase.
Read more: Growth slowdown: Why lay a deeper economic malaise at RBI’s door?
What about the weakening rupee?
That’s another headache for Malhotra. The rupee has been weakening against the dollar, more so since Donald Trump was re-elected as president of the US. The dollar index has risen 3% since 5 November. The fact that the rupee weakened by just 0.8% was largely due to RBI’s intervention, selling US dollars in the market. According to some estimates, the central bank has sold dollars worth $38 billion between October and December first week even as India’s foreign exchange reserves dropped to a five-month low.
And then there is policy uncertainty...
The new governor has to decide how long he can continue protecting the rupee. The Chinese Yuan has declined by 2.6% since Trump’s re-election. Should he allow the rupee to weaken to maintain India’s manufacturing competitiveness? If so, how much can he allow without causing the cost of imports to go up fuelling inflation further? He must also watch out for Trump’s policies which could cause sharp investment outflows, trigger trade wars, slow global economic growth and hurt Indian exports.
