Overreaction in Indian Monetary Policy

Before the onset of the global financial crisis, the Indian economy was growing at more than 9%. There were signs of inflationary pressure but it was largely presumed to be the result of high growth rate and high world food inflation. As the crisis unfolded, both monetary and fiscal authorities responded quickly to maintain the growth momentum. Between August 2008 and April 2009, the policy repo rate was reduced from 9% to 4.75%, and the 15 to 91 days’ treasury bill rate followed that cut. There was a quick growth recovery, following macroeconomic stimulus. In the very beginning of the crisis, crude oil prices crashed but soon started increasing. Inflation followed crude oil prices and food inflation that had remained high.

The Reserve Bank of India (RBI) started interest rate tightening to counter inflation in 2010. But, from 2011 onwards growth rates started declining substantially as multiple shocks occurred, including a fall in export growth due to the European debt crisis. Whereas the interest rates continued to increase and the trend growth kept sliding down (Figure 1). The repo rate peaked at 8.5% in October 2011. A slight decrease in 2012 was quickly reversed from mid-2013 as part of the interest rate defence following the United States (US)-led taper-on crisis. India was also moving towards a flexible inflation targeting (FIT) regime and formally adopted it as the nominal anchor of monetary policy in 2016. Although inflation targeting was supposed to be flexible, it was implemented rather stringently, debatably as an overreaction post the global financial crisis laxity. The RBI has been criticised for more than necessary post-crisis stimulus and late response to inflation.