RBI’s Shaktikanta Das warns against strong monetary policy tightening

Reserve Bank of India Governor Shaktikanta Das on Friday expressed optimism about India’s economic resilience, driven by robust domestic demand, as he listed slow moderation in inflation as one of the biggest challenges to the global economy. 

Speaking at the inaugural Kautilya Economic Conclave in New Delhi, Das said slow moderation in inflation which is getting interrupted by recurring and overlapping shocks, slowing growth, and lurking risks of financial instability are the three biggest challenges to the global economy.

Despite the global economic challenges, Das emphasized India’s ability to weather these issues. Das highlighted the country’s strong economic fundamentals and its role as a potential global growth engine.

The RBI governor acknowledged the intricate relationship between price stability and financial stability. He pointed out that strong monetary policy measures addressing high inflation might have unintended consequences on financial stability, emphasizing the need for a balanced approach.

“Periods of high inflation that are addressed by strong monetary policy tightening can deter financial stability if interest rate risks are not adequately factored in. It is, therefore, evident that the relationship between price stability and financial stability depends upon the policy choices that we make,” Das said.

“Price stability and financial stability complement each other. In fact, price stability is an anchor for financial stability, but the trade-off between the two becomes a close call at times,” Das explained.

“It has been our endeavor to manage these complementarities and trade-offs as efficiently as possible. While according priority to price stability keeping in mind the objective of growth, as mandated under the law, we treat financial stability as non-negotiable. Our policies and choices of instruments are guided by this holistic approach. We have strengthened our macroeconomic fundamentals and buffers, and these are imparting resilience to the economy to withstand large shocks and navigate in an increasingly turbulent and uncertain global setting,” he added.

The RBI Governor discussed the central bank’s role in maintaining both monetary and financial stability, noting that financial stability, while not explicitly quantifiable, is a crucial aspect of the RBI’s mandate. “Unlike price stability, financial stability is not specifically defined and not explicitly quantifiable. As a result, it has been interpreted subjectively specific to the context and circumstances,” he said. 

Regarding India’s current monetary policy context, Das pointed out that the 250 basis point increase in the repo rate from May 2022 to February 2023 is still working through the financial system. He emphasized the RBI’s continuous vigilance regarding evolving inflation dynamics.

On policymaking, Das said it has become extraordinarily complex as financial markets have become highly sensitive to every piece of new information. 

In terms of financial stability, the RBI has undertaken prudent initiatives to strengthen the regulation and supervision of banks and non-banking financial companies (NBFCs), thereby enhancing the stability of the Indian financial sector. This approach has resulted in stable growth in bank credit, improved asset quality, adequate capital, liquidity buffers, and strong earnings growth. While the financial indicators of NBFCs align with the broader financial system, Das reminded us that it’s vital to remain vigilant during favorable economic conditions.

“Banks, NBFCs, and other financial sector entities should remain vigilant and complete the pending repairs, if any, to their houses. Roofs need to be fixed, walls need to be further strengthened, and foundations need to be augmented when the weather is good to withstand potential adverse weather events in the future,” he added.