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The past few months have presented a mixed outlook for India’s economy. On the positive side, the country saw record-high remittances, substantial increases in direct tax collections, significant growth in the alternative assets market, and a reduction in the fiscal deficit compared to the previous year. Globally, the outlook was similarly optimistic, with the US job market remaining robust, global economies experiencing disinflation, and interest rates being reduced by the US Federal Reserve and European Central Bank, all of which contributed to renewed optimism about global growth prospects. However, despite these positive signals, India’s economic growth rate slowed to a near two-year low of 5.4% in the September quarter (Q2FY25). The manufacturing and mining sectors weakened, the Index of Industrial Production (IIP) contracted by 3.8% in October, and exports fell by 1.6% in November.

As a result, RBI Governor Shaktikanta Das faced indirect accusations of deliberately maintaining high interest rates, sparking a heated debate in mid-November. Commerce Minister Piyush Goyal claimed that high interest rates were exacerbating India’s economic slowdown and urged the RBI to reduce rates. He also criticized the inclusion of food inflation in headline inflation calculations as “flawed.” Finance Minister Nirmala Sitharaman echoed similar concerns, highlighting the pressure high lending rates placed on borrowers and emphasizing the need for “affordable” interest rates. Chief Economic Advisor Anantha Nageswaran also suggested excluding volatile items like tomatoes, onions, and potatoes from inflation calculations to reduce the inflation rate significantly.

The criticism of Governor Shaktikanta Das intensified when India’s GDP growth rate for the September quarter slowed to 5.4%, with some blaming Das for failing to interpret market signals and act accordingly. The RBI had previously projected India’s economic growth at 7.2% for FY25, with inflation forecast at 4.5%. However, Das maintained that cutting interest rates would be “premature” and “risky,” given the significant inflation risks. Despite the criticism, Das reiterated that the RBI’s primary objective was to control inflation, and a rate cut could undermine that goal. At the December 2024 Monetary Policy Committee (MPC) meeting, under Das’s leadership, the RBI opted not to change the repo rate but instead decided to cut the Cash Reserve Ratio (CRR) by 50 basis points to 4%, releasing ₹1.16 lakh crore into the banking system. This move was aimed at striking a balance between maintaining economic stability and ensuring adequate liquidity in the financial system.

Clashes between central bank governors and governments are not unique to India. Historically, similar tensions have been observed worldwide. US Federal Reserve Chairman Marriner Eccles (1934-1948) resisted President Roosevelt’s pressure to inflate the economy, leading to a standoff. Paul Volcker (1979-1987) also faced criticism from President Jimmy Carter for his tight monetary policy to combat inflation. In the UK, Bank of England Governor Montagu Norman clashed with Chancellor of the Exchequer Winston Churchill (1920s) over the return to the gold standard. In India, RBI Governor I.G. Patel (1977-1982) resisted Indira Gandhi’s government’s pressure to print more money to finance fiscal deficits, creating tensions. Bimal Jalan, RBI Governor from 1997-2003, had differences with the Vajpayee government on issues like interest rates and fiscal policy. These historical examples demonstrate that such tensions are common, as the independence of central banks and their focus on price stability often conflict with governments’ priorities for short-term economic growth and political considerations.

The landscape of economic thought has evolved over the past century. John Maynard Keynes significantly influenced government policies to address economic challenges during the Great Depression, advocating for fiscal measures to stabilize economies. However, in the latter half of the 20th century, Milton Friedman’s monetarist ideology gained prominence, emphasizing monetary policy as the primary tool to manage inflation. Leaders like President Ronald Reagan and Prime Minister Margaret Thatcher adopted Friedman’s ideas, prioritizing monetary stability. This legacy continues today, with governments focusing on economic growth and central bank governors concentrating on controlling inflation, leading to persistent tension between these two objectives. This tension between growth and inflation goals results in conflicting policy decisions, posing an ongoing challenge for policymakers.

The Indian government’s decision not to extend Shaktikanta Das’s tenure reflects these underlying tensions. The conflict is believed to have centered on the government’s desire to boost economic growth, while Das focused on maintaining price stability and preserving the RBI’s independence. This challenge is now faced by the new governor, Sanjay Malhotra. Malhotra’s task is daunting, as India’s economic growth has slowed, inflation remains elevated, and the rupee is under pressure. In its latest Monetary Policy Committee review, the RBI revised its growth forecast for the current fiscal year from 7.2% to 6.6%, while increasing its inflation target for the year from 4.5% to 4.8%. The following analysis highlights the various challenges that the new RBI Governor will face.

Controlling Inflation

While headline inflation of 5.48% in November 2024 remains within the RBI’s target tolerance range of 2-6%, food inflation continues to be a significant concern. Except for July and August 2024, food inflation has remained above the tolerance limit. The MPC aims to reduce food inflation to 4% by FY26, but this will require careful planning. It is also important to note that headline inflation is heavily influenced by food inflation. For example, when food inflation was low in July and August 2024, headline inflation also remained low.

The reasons for high food inflation are multifaceted. Weather unpredictability affects food production, leading to supply chain disruptions. Erratic rainfall patterns, for instance, negatively impacted vegetable production, contributing to double-digit inflation for nearly eight consecutive months. Additionally, inefficiencies in the agricultural sector and the government’s decision to raise import duties on edible oils have further strained household expenses. The RBI Governor must also consider how high food inflation could shape public expectations about future inflation, leading to higher wage demands and sticky inflation. Former Governor Shaktikanta Das adopted a cautious approach to monetary policy, maintaining the repo rate at 6.5%. Malhotra will need to navigate these concerns while balancing the government’s desire for economic growth.

Balancing Growth and Inflation

Table 2 illustrates that quarterly GDP growth in India has steadily decreased over the past four quarters, indicating a trend of slowing growth amidst persistent inflation, raising concerns about stagflation.

The continuous decline in India’s GDP can be attributed to various factors, with the slowdown in the manufacturing sector being a key contributor. Manufacturing growth

slowed to 2.2% in Q2FY25 from 7.4% in Q1FY25, driven by weak performance in manufacturing companies, reduced mining activity, and lower electricity demand. High inflation has also dampened GDP growth by reducing disposable income and curtailing private consumption. Additionally, adverse weather conditions, geopolitical uncertainties, and financial market volatility have posed risks to both inflation and GDP growth.

This scenario presents a significant challenge for the RBI Governor, who must carefully balance price stability and growth while ensuring that the decline in GDP does not lead to excessive exchange rate volatility.

Stabilizing Depleting Foreign Exchange Reserves

India’s foreign exchange reserves have been dwindling due to a combination of factors. The country’s trade deficit has widened, primarily driven by increased imports of oil and gold. Additionally, capital outflows have surged in response to China’s stimulus packages. The RBI has been intervening in the currency market to stabilize the rupee, which has also contributed to the depletion of reserves. The Indian rupee is nearing record lows, driven by high global demand for dollars and foreign investment outflows.

The RBI Governor will need to manage liquidity in the economy to prevent adverse impacts on financial stability. Malhotra will need to employ a multi-pronged strategy, including monetary policy adjustments to attract foreign capital, foreign exchange interventions to stabilize the rupee, and collaboration with the government to implement policies promoting exports, reducing imports, and attracting foreign investment.

In conclusion, as Sanjay Malhotra takes on his new role, his primary challenges will be controlling inflation, balancing growth, and stabilizing foreign exchange reserves. Effective management of these areas will be crucial to maintaining investor confidence, stabilizing the rupee, and supporting India’s economic growth. All eyes are now on Mint Road as Malhotra steers India through these domestic and global challenges, shaping the nation’s financial future.