Monetary policy should lead the easing cycle our economy needs

Weak demand in the economy needs a response but budget tightening would mean the central bank must look for easing space

- NIRANJAN RAJADHYAKSHA

The coming weeks will see two important policy events. Finance minister Nirmala Sitharaman will unveil the first full budget of the third Narendra Modi government. And the six members of the committee that sets interest rates will meet for the first time since Sanjay Malhotra took charge as governor of the Reserve Bank of India (RBI).

Indian macro policy has been tight at a time when domestic demand from households, firms and the government shows signs of weakness. There are three clues that tell the story. First, the growth in gross domestic product (GDP) has been declining for three quarters in a row. Second, core inflation has been well under control in the 12 months to November 2024. Third, the current account shows no signs of excess domestic demand that could be spilling over into higher imports.

The tricky question is how macro policy can be eased this year. There are times when the evidence is so stark that both fiscal as well as monetary policy can be either eased or tightened at the same time. One recent case was when the pandemic struck five years ago. There was a compelling case for coordinated action to support domestic economic activity.

The other case was in the early years of the previous decade, when double-digit inflation combined with a widening current account deficit created a compelling case for coordinated action in New Delhi and Mumbai to cool down the economy.