In times of sharp economic contraction and increasing inflation pressures amid the coronavirus pandemic situation, will RBI go for another rate cut? That's a tough choice to make for Reserve Bank of India (RBI) Governor Shaktikanta Das during these trying times.

As reported by Reuters, the decision on rate cuts will be announced by RBI at a policy review meeting to be held on Thursday, August 6. Economists who participated in the Reuters survey, expect RBI to cut repo rate by 25 basis points and cut reverse repo rate by 35 basis points, before a long economic pause.

Reserve Bank of IndiaReuters

It is to be noted that RBI has already reduced the repo rate significantly by 135 basis points since last year, and by 115 bps since February 2020. In an earlier push by MPC to banks following rate cut, they have already transmitted 72bps cuts to customers on fresh loans.

The rise in CPI-based inflation levels and RBI mandate on MPC

Thriving in an environment of economic uncertainty, with the rise in CPI-based annual inflation over 6 percent for the last two quarters (January-March and April-June), above RBI's medium-term range of 2 to 6 percent and increase in NPAs, it is required of India's central bank to focus on formulating policies for financial stability and economic growth.

According to the RBI mandate, it is expected of the Monetary Policy Committee (MPC) to maintain consumer price index (CPI)-based inflation at 4 percent. If average inflation for three consecutive quarters, undershoots or overshoots the range between 2 to 6 percent, as witnessed now, then it is seen as a failure of the monetary policy for which RBI owes an explanation to the Parliament.

Further, it is required of the Reserve Bank of India to come up with a strategic plan of action to bring back the CPI-based inflation within the preset range to ensure financial stability. According to Reuters poll, the Indian economy is likely to contract by 20 percent, a 5.1 percent shrink will be witnessed, to record weakest economic performance after 1979.

RBI prioritizes inflation concerns over financial stability

Earlier in May, RBI had announced a 40 bps cut in repo and reverse rates, prompted by the MPC's concerns over the severity of the pandemic's macroeconomic impact. This meant shifting its focus from inflation control to financial growth.

In an earlier policy announcement, MPC had refrained from predicting inflation and providing guidance on GDP growth for fiscal 2021. However, MPC is of the view that the rise in inflation will remain firm till the first half of FY21, but will gradually ease towards the second half of the year 2021, supported by a favourable base effect. In Q3 and Q4 of FY21, MPC anticipates the headline inflation to fall below the target of 4%.

Economists believe that inflation is largely caused due to supply-side disruptions witnessed with sudden Covid-19 outbreak this year, and a fall in consumer demand which did not result in price reduction either.

RBI governor Shaktikanta Das had said: "Given all these uncertainties, GDP growth in 2020-21 is estimated to remain in negative territory, with some pickup in growth impulses from H2 2020-21 onwards."