A Balancing Act

The Reserve Bank of India (RBI) increased its policy rate by 25 basis points to 5.5 per cent on October 7. This was the first time since February 2023 that the central bank raised the repo rate. A combination of factors that included a build-up of inflationary pressures, continuing robust growth and global uncertainties prompted the step.

Importantly, RBI also changed its policy stance from “neutral” to “calibrated tightening.” This means that rate reductions are off the table now and a pause or interest rate increases will remain in RBI’s set of actions. The last time the rate tightening cycle ended was in February 2023, more than three-and-a-half years ago. During this period, effective coordination of monetary and fiscal policy led to robust economic growth even as price stability was maintained. It is worth pointing out that these years were far from normal and wars, supply chain pressures and a deteriorating environment for global trade posed challenges for economic growth.

The central bank projected economic growth for 2026-27 at 7.1 per cent, increasing its projection by 0.4 percentage points from its previous estimate. Real GDP growth in the first quarter of 2027-28 (Q1, 20227-28) is pegged at 7.1 per cent Importantly, RBI also increased its inflation projection for 2026-27 to 5.2 per cent. In the next three quarters (Q1, Q2, Q3, 2026-27), the forecast for inflation is 5.8 per cent, close to the upper bound of RBI’s zone of comfort for inflation. This combination of high growth increasing inflation meant RBI had to act, sooner or later, and sooner the better.

Explaining the rationale for the choice made on October 7, RBI said, “In the light of available data, it is clear that inflation and its outlook are not benign as they were last year with headline CPI inflation expected to average almost 5.8 per cent in the next three quarters and core inflation projected at 4.4 per cent this year. In this milieu, recalibrating the policy rate is imperative.”

This probably is not the last interest rate increase in this rate tightening cycle. Economists expect anywhere from 25 to 50 basis points of further interest rate increases. The debate before RBI’s Monetary Policy Committee (MPC) took the decision on October 7 was about the quantum of increases and the instruments of choice. A 50 basis points increase in rates would have been alarmist and was not on the table. Another option was the combination of a 25 basis point increase along with sucking out of liquidity by using Variable Reverse Repo Rate (VRRR) auction where banks participate in competitive bidding to “discover” the interest rate at which they are willing to park their surplus funds with RBI; use of Open Market Operations (OMOs) by RBI to sell government securities in the market, thus draining liquidity and other instruments such as forex swaps and forex sales. For the moment, these instruments have not been used.

Growth and inflation trade-offs require management via monetary and fiscal policy coordination. The Narendra Modi government has prioritised growth—and has delivered 7 per cent growth for multiple years—but not at the cost of price stability. After the agreement on monetary policy framework between the Union government and RBI in February 2015, the usual tug of war between the government and RBI over policy rates came to an end. The problem now is no longer political but more or less economic. For example, if economic growth rises above potential growth, an inflationary gap opens up. Increasing potential growth via investment and capacity building has, of course, been a priority for the government.

MARCO RUBIO AT THE ACROPOLIS

Standing in front of the Acropolis in Athens, Marco Rubio, the US secretary of state, delivered a virtual tour of “Western civ” to his audience on October 7. The speech started with the Persian Wars of antiquity but ended, predictably enough in Trumpian fashion, with American chest-thumping.

“Under President Trump, the United States has made its choice. We choose the unapologetic pursuit of national power: to take back control of our critical supply chains, to reindustrialize our economy, to rebuild over defence, to fight for dominance of the technologies and industries of the future,” Rubio said.

Never has a US secretary of state delivered a speech that begins with Herodotus and ends with something as mundane as supply chains. What Rubio said was not unexpected. A year ago, Michael Ignatieff, a Canadian scholar of human rights and a prolific author, noted that Trump’s thinking ran along “spheres of influence.” Far from forging a new concert of the West, under Trump, the US has come close to annexing territories such as Greenland—a part of the Kingdom of Denmark—and even weakening NATO.

While this is par for the course in a Jacksonian America, the world thinks differently. Key partners in the Western alliance have been offended badly. Canada and Denmark are immediate examples, but who knows that in the future anyone could be targeted. Non-Western partners, such as India, have not been spared either.

From 1991 to 2025, the US did pursue its interests. Its interests were far more encompassing and global in nature. Chief among them were an open--rules-based--liberal order and the maintenance of global political order. Under Trump, the first has been abandoned and the second is increasingly difficult. America’s pursuit of national interest will be lonely.