India’s central bank said on Thursday that the economy’s natural rate of interest has increased since the pandemic and will rise further, driven by the growth of potential output, which analysts said could limit the scope to ease monetary policy.

The natural rate of interest is associated with an economy operating at full capacity without generating inflationary pressures, and though not observable, it serves as a reference point for monetary policy, the RBI said in its bulletin.

It estimated the natural rate was 1.4-1.9 per cent in the fourth quarter of 2023-24, higher than the 0.8-1.0 per cent in the third quarter of 2021-22, the last time it made an estimate, the central bank said.

“When the policy rate is set below the natural rate, the stance is regarded as accommodative, and the converse signifies a restrictive stance. The policy stance is neutral when the real policy rate is at the level of the natural rate,” the RBI said.

With inflation at 5.1 per cent and the central bank’s key lending rate set at 6.5 per cent, the real rate stands at 1.4 per cent. That could increase to 2 per cent based on the RBI’s estimate of an average inflation of 4.5 per cent for this fiscal year.

The RBI’s wide estimate for the fourth quarter fed into the narrative of both its hawkish and dovish monetary policy committee members, said Gaura Sen Gupta, chief economist at IDFC First Bank.

“The lower range of the neutral rate indicates space to cut interest rates by 50 basis points in FY25, while the upper range indicates no space to cut rates. We maintain expectations of a shallow rate cut cycle starting from October/December,” she said.