GDP growth is heading for a slowdown in several countries. Fiscal policy support has been inadequate globally as debt-GDP ratio remains high. Although inflation risks have abated, headline retail inflation remains above the target level in several systemically important countries.

Major central banks such as the US Fed, the Bank of England and the European Central Bank recently preferred to pause amid an easing policy cycle due to prevailing uncertainties.

Public policy should be countercyclical and forward-looking. Data availability on economic cycles is lagged by at least one quarter. Once an economic cycle starts, it gets going for some time. Economic cycles are typically asymmetric as the duration of downswings and upswings are generally not identical.

Moreover, turning points are difficult to ascertain in advance. In such a situation, public policies are data-dependent and most unlikely to be forward-looking.

Endowed with several instruments, the government can combine reactive and forward-looking fiscal policy. While pressing data-dependent problems can be addressed through reactive fiscal policy, aspirational goals can be achieved through forward-looking structural reforms.

Forecast dilemma

As central banks do not have the luxury of having multiple instruments, they are either data-dependent (reactive) based on information available at the time of policy announcement or forward-looking based on growth-inflation forecasts.

As growth-inflation forecasts play a critical role in pursuing forward-looking monetary policy central banks deploy their best brains for this purpose and revisit growth-inflation forecasts before announcing monetary policy at fixed intervals — monthly, bimonthly, or quarterly. Unfortunately, growth-inflation forecasts have been imprecise in recent years with unusually high forecast errors for several reasons.

First, supply shocks are more frequent in the 21st century due to climate-related risks with energy and food prices evolving unpredictably.

Second, anti-globalisation policies lead to artificial supply shocks, the latest being a highly complex tariff war.

Third, geopolitical risks are man-made and contribute heavily to supply chain disruptions with rising prices, at least in the affected regions.

Fourth, the Covid-19 pandemic suddenly disturbed the economic cycle since 2020 with price determination largely abstracting from the wage-price spiral.

Fifth, idiosyncratic factors also influence retail prices in several countries.

Is this a one-off situation or will supply-side uncertainties continue to dominate inflation expectations?

It is difficult for central banks to pursue forward-looking monetary policy when their growth-inflation projections go haywire under multiple uncertainties. Are they at the crossroads? Should they pursue a reactive monetary policy based on past data or a forward-looking monetary policy based on highly unreliable growth-inflation forecasts?

The post-Covid recovery based on available excess capacity was short-lived. Unless additional capacity is created through fresh investment — both public and private — supply-side problems cannot be resolved on an enduring basis. Alternatively, there is a need to improve productivity through innovations and structural reforms, which requires coordination between monetary and fiscal policies.

Central banks have expertise in demand management. Hence, they initially ignored the post-Covid spurt in retail inflation as a temporary supply-side problem. When they realised that repeated supply shocks and their second-round effects lead to generalised inflation, policy tightening was rapid and large in magnitude.

Although a global recession was averted, the recent slowdown could be partly attributed to tight monetary policy. Major central banks are hesitatingly pursuing a policy easing cycle.

Indian Scenario

India’s public policy discourse has been somewhat different. During the pandemic and its aftermath, the monetary authority had to do heavy lifting while fiscal support was need-based. While controlling post-COVID inflation, the RBI paused well before many systemically important central banks. Despite the recent slowdown, India is still the fastest-growing major economy in the world. The headline inflation has fallen below the 4 per cent target in February 2025.

Notwithstanding climate concerns, farm output in FY25 may be at a historic high level. Growth is being supported as we are growing below our potential. The public policy support has been need-based — capex-heavy fiscal consolidation combined with a repo rate cut since February 2025. There is no threat to fiscal profligacy as the government is committed to fiscal consolidation. The stance of monetary policy is still neutral.

Notwithstanding global uncertainties, India’s macro parameters are encouraging. GDP growth is expected to be better in the second half of FY25. The pressure on the rupee has abated significantly after mid-March due to FIIs returning to the Indian stock market. The liquidity condition has improved following multi-pronged initiatives by the RBI.

The market is confident that the Monetary Policy Committee will cut the repo rate by another 25 basis points in April 2025 to expedite the monetary policy transmission.

Hopefully, our MPC will not be unduly influenced by global uncertainties as India’s medium-term fundamentals are strong.

India needs a low interest rate regime to counter both cyclical slowdown and structural problems. Government initiatives and low interest rate regime will complement each other.

India’s development problems are mostly structural. The future-ready workforce is a major challenge. The quality of education could not be improved significantly. The women’s participation rate in the labour force is low despite a recent uptick. Labour productivity is low and the share of wages in GDP is falling in India, which has implications for inequality.

Next-generation reforms in the product and factor markets have seen roadblocks in the past. Climate risks were not a constraint for 34 middle-income countries, which transitioned to the high-income group in the last 34 years.

The new experiment, proposed in the FY26 budget, such as promoting MSMEs, agriculture, and rural prosperity may not achieve its objectives without supporting monetary policy.

The Deregulation Commission is expected to be constituted soon which would augment ease of doing business. States must play a critical role in structural reforms in the product and factor markets.

Finance should not be a constraint while pursuing innovations and structural reforms. India’s Repo rate is one of the highest among its peers. Unless the domestic interest rate structure is globally competitive, Indian investors may prefer to invest in overseas markets.

The writer is the former Head of the Monetary Policy Department of RBI. Views expressed are personal