On interest rates, can’t be both dovish & hawkish

Why in the News

The Monetary Policy Committee of the Reserve Bank of India (RBI) voted unanimously at its last meeting to hold the benchmark repo rate at 5.25 per cent, in a policy read as more dovish than expected. The minutes of that same meeting, released a few days ago, point the other way. Members drawn from the central bank displayed a distinct hawkishness, and the Bank’s own inflation projections imply negative real interest rates on a forward basis. The divergence is the problem: a stance described as neutral cannot be reconciled with projections that would stimulate activity, nor with a growth assessment the Bank itself calls resilient.

What is a monetary policy stance?

1. What it signals: The stance states the direction of the committee’s next expected move on the policy rate. That signal is separate from the rate set on the day.
2. Accommodative: The committee signals that the next move is a cut, or that liquidity will stay supportive of demand.
3. Neutral: The committee commits to no direction and keeps both a cut and a hike open at the following meeting.
4. Tightening or withdrawal of accommodation: The committee signals that the next move is a hike, or the removal of surplus liquidity from the system.

What is the real interest rate?

1. Definition: The real interest rate is the nominal policy rate less expected inflation, so it measures what a lender actually earns once prices have risen.
2. Why the sign matters: A negative real rate makes money cheaper than the rate at which prices are rising, which pushes households and firms toward borrowing and spending.

What did the last policy decision signal?

1. The stance retained: The committee kept the stance neutral alongside that hold.
2. The tone: The policy read as more dovish than many analysts had expected at the time.
3. The inference drawn: Analysts concluded that rate hikes were not imminent, even with inflation projected above target.

How do the minutes of the same meeting read differently?

1. A reversal in signal: The minutes suggest the current situation is unlikely to be maintained over the near term, and the divergence from the policy statement is striking.
2. The internal members hardened: That hawkishness came from the members drawn from the central bank, not from the committee as a whole.
3. How far each went: An assessment by economists at the State Bank of India reads the Governor’s minutes statement as showing an inclination toward policy tightening, records a Deputy Governor calling for a possible rate hike later in the year, and notes an Executive Director stopping just short of the same call.
4. A different objection from outside: External members of the committee drew attention instead to the real interest rate.

Can a neutral stance sit with negative real interest rates?

1. The projections: The Bank has pegged inflation at 5.9 per cent in the third quarter, 5.5 per cent in the fourth quarter, and 5.3 per cent in the first quarter of the next financial year.
2. What they imply: Against a repo rate of 5.25 per cent, those projections put real interest rates in negative territory on a forward basis.
3. What negative real rates do: They stimulate economic activity, which is a different setting from the stance the committee has adopted.
4. What neutral is supposed to mean: The Governor has previously stated that a neutral stance implies no support for economic activity and no support for controlling inflation.
5. The growth assessment compounds it: The Bank describes growth as resilient, supported by domestic demand, sustained expansion in manufacturing and services activity, and robust exports, which removes the case for a stimulative real rate.

What does the same uncertainty look like at other central banks?

1. A shared condition: Central banks across the world are grappling with uncertainty over inflation and over the course of monetary policy.
2. The United States: The Federal Reserve maintained interest rates in July, and the path of policy after that remains unclear.
3. The same gap between decision and minutes: The minutes of that Federal Reserve meeting record that several participants favoured an increase of 25 basis points in the target range.

What will decide the next move?

1. The October meeting: By the time the committee meets next in October, there should be more clarity on agriculture and on the trajectory of inflation.
2. The projections as the signal: The Bank’s revised inflation projections will show what it expects of underlying price pressures going forward.
3. The consequence: Those expectations are what would produce an adjustment in the policy rate.

Challenges to India’s flexible inflation targeting framework

1. A headline target moved by food: Food and beverages carry close to half the weight in the Consumer Price Index, so the target responds to harvests that no policy rate can influence. Eg. Vegetable price spikes pushed headline inflation above the upper tolerance band in 2023 and 2024. Core inflation stayed subdued through the same period. Fix. Publish an explicit core inflation reference alongside the headline target, so the committee’s tolerance for supply shocks is visible in advance.
2. An ageing consumption basket: The index in use rests on a consumption pattern captured years ago, so the measured basket drifts from what households actually buy. Eg. Services such as data, health insurance and education are underweighted relative to current household spending. Fix. Fix a statutory revision cycle for the index base year so the measure and the target are reset together.
3. Exchange rate pressure competes with the target: Rate decisions taken for domestic prices collide with the management of capital flows. Eg. Record foreign portfolio outflows in 2025-26 forced heavy intervention to steady the rupee. Fix. State an explicit order of priority between the inflation target and exchange rate smoothing in the policy statement.
4. No fiscal counterpart to the target: The framework binds the central bank alone, with no matching commitment on borrowing. Eg. Heavy government borrowing keeps longer tenor yields elevated regardless of where the repo rate is set. Fix. Pair each five year target reset with a stated debt to gross domestic product path under the Fiscal Responsibility and Budget Management Act, 2003.
5. Accountability stops at a report: A sustained breach obliges a report and nothing further. Eg. The report on a target breach goes to the Central Government and is not laid before Parliament. Fix. Require the report to be tabled in Parliament with a stated corrective path and a review date.

Conclusion

A unanimous hold read as dovish now sits alongside minutes that record internal calls for tightening and projections that imply negative real rates. The policy statement, the stance and the projections are describing three different settings, and only one of them can be the policy. The October meeting, with clearer information on agriculture and on the inflation trajectory, is where that inconsistency has to be resolved into either a rate move or a change of stance.

“[2023] Consider the following statements :

Statement-I: In the post-pandemic recent past, many Central Banks worldwide had carried out interest rate hikes.

Statement-II: Central Banks generally assume that they have the ability to counteract the rising consumer prices via monetary policy means.

Which one of the following is correct in respect of the above statements?

(a) Both Statement-I and Statement-II are correct and Statement-II is the correct explanation for Statement-I

(b) Both Statement-I and Statement-II are correct and Statement-II is not the correct explanation for Statement-I

(c) Statement-I is correct but Statement-II is incorrect

(d) Statement-I is incorrect but Statement-II is correct