Risks to foreign capital flows

Mind the gap 10-year government bond yields (%)

- RAJESH KUMAR

Data released last week showed that India's retail inflation rate declined to 2.8 per cent in May, the lowest in 75 months. Significant moderation in previous months enabled the Reserve Bank of India's (RBI's) Monetary Policy Committee (MPC) to reduce the policy repo rate by 50 basis points on June 6, as against the expectation of a 25 basis point cut. Along with front-loading the rate cut, the MPC noted that monetary policy is left with very limited space to support growth. Some private-sector economists have argued that the inflation rate in the current year will be significantly lower than the RBI's projection of 3.7 per cent, potentially creating space for further rate cuts. While a lower policy rate will reduce the cost of funds and support economic activity, its impact on capital flows and the external financial position will require close attention. The Israel-Iran conflict, which could increase risk aversion in the near term, will also need to be closely monitored.