India’s real rate moment, the cost of delay

India is approaching an uncomfortable turning point in monetary policy. With the Reserve Bank of India (RBI) holding the repo rate at 5.25% while inflation rises, the real policy rate is steadily losing its cushion. Consumer price inflation rose to 4.82% in August , from 4.45% in July , marking the third consecutive month above the RBI’s target of 4%. Food inflation is even higher at 5.95%. Core inflation has also risen to around 4.2%, suggesting that price pressures are broadening beyond food.

A view on the real interest rate is not obtained simply by subtracting yesterday’s inflation from today’s policy rate. Monetary policy operates through expected inflation. If the repo rate remains at 5.25% while inflation expectations move towards 5.25%, the ex-ante real policy rate becomes approximately zero. That is a very different monetary environment from the one in which the real policy rate is comfortably positive.