RBI Rate Cut May Be Out Of The Window As Neutral Rate Estimated At 1.4-1.9%

Expectations of a rate cut by the Reserve Bank of India might be pushed further down the line if the central bank's latest research is anything to go by. The natural rate of interest for India has seen an upward shift post-pandemic, driven by the growth of potential output, according to its latest bulletin.

The natural rate of interest is associated with an economy operating at full capacity without generating inflationary pressures. "The estimate of the natural rate for Q4FY24 is 1.4–1.9% as compared with our earlier estimate of 0.8–1.0% for Q3FY22," the central bank said.

As the natural rate is not observable, it has to be estimated, as it is crucial for setting appropriate monetary policies and assessing them. These estimates are centred on wide bands of uncertainty, warranting careful interpretation in the assessment of the monetary policy stance.

The difference between the real policy interest rate and the natural rate measures the monetary policy stance. Currently, the repo rate or benchmark lending rate, is 6.5%. If the policy interest rate adjusted for inflation is higher than the natural interest rate, monetary policy is judged to be either anti-inflationary or contractionary. But if the real policy rate is lower than the natural rate, monetary policy is regarded as expansionary or accommodative.

When the real repo rate is at or close to the natural rate, monetary policy is neutral, that is, neither expansionary nor contractionary. This situation is expected to prevail when inflation is aligned with the target and output is at or close to its potential level.