Interest rate cut can be possible in Q1FY25 but that, too, would be data dependent

Interest rate cut can be possible in Q1FY25 but that, too, would be data dependent

The Reserve Bank of India‘s (RBI) Monetary Policy Committee (MPC) convened on August 10 and decided to maintain the repo rate at 6.5 percent. This decision aligns with the predictions of market analysts and experts.

As a result of this decision, the standing deposit facility (SDF) rate, which pertains to the rate at which banks park excess funds with the RBI, will also remain unchanged at 6.25 percent. Similarly, the marginal standing facility (MSF) rate and the Bank Rate, which act as the upper and lower bounds of the interest rate corridor, will remain steady at 6.75 percent.

The MPC’s prevailing stance, known as the ‘withdrawal of accommodation,’ has been upheld with a majority of 5 out of 6 members supporting it. This suggests that the RBI is taking steps to gradually reduce the accommodative measures that were implemented to counter the economic impact of the COVID-19 pandemic.

This approach is deemed appropriate due to the current state of liquidity, which has transformed into a substantial surplus. This liquidity surplus is likely a result of the various monetary policy measures introduced by the RBI to stimulate economic activity.

A notable factor that influenced the MPC’s decision is the recent increase in inflation. The data suggests an uptick in inflation, particularly in food prices. As a response to these inflationary pressures, the RBI has adjusted its inflation forecast upward. Consequently, the decision to maintain the status quo on interest rates and continue the withdrawal of accommodation stance can be seen as a ‘hawkish pause.’ In other words, the central bank is opting for a more cautious and vigilant approach to address inflationary concerns.

In summary, the RBI’s MPC has decided to keep the repo rate unchanged at 6.5 percent, along with maintaining the existing rates for SDF, MSF, and the Bank Rate. The majority of the committee members supported the ‘withdrawal of accommodation’ stance, reflecting the cautious approach to policy normalization.

This decision was influenced by the current liquidity surplus and the rise in inflation, particularly in food prices, prompting the central bank to adopt a vigilant stance regarding monetary policy. This move was largely anticipated by the market, aligning with the broader economic expectations.

In June 2023, India’s Consumer Price Index (CPI) inflation rate experienced a moderate increase, reaching 4.8 percent, compared to 4.3 percent in the previous month of May 2023. It is worth noting that this inflation rate remains within the tolerance band set by the Reserve Bank of India (RBI). The primary driver behind this uptick in inflation was a significant surge in food inflation, which escalated to 4.6 percent from 3.3 percent just a month earlier.

This sudden rise in food inflation can be attributed to a variety of factors, including irregular monsoon patterns and heatwave conditions. These climatic variations have led to a sharp increase in the prices of certain components within the category of vegetables. The uneven distribution of rainfall and the occurrence of heatwaves have impacted agricultural output and consequently contributed to this upward pressure on prices.

As a response to these developments, the RBI made substantial revisions to its inflation projections in the near term. The forecasts for the second quarter of the fiscal year 2023-24 (Q2FY24) and the third quarter of the same fiscal year (Q3FY24) were adjusted upward by 100 basis points (bps) and 30 bps, respectively. The revised projections now stand at 6.2 percent for Q2FY24 and 5.7 percent for Q3FY24. These revisions reflect the heightened upside risks emanating from food prices.

However, it is important to note that while the increase in vegetable prices could pose a potential upside risk to CPI inflation in the coming months, there is a belief that this uptick is of a more transient nature. Historical trends suggest that such spikes in vegetable prices tend to moderate over time, and this pattern is expected to continue. As the fiscal year progresses, it is anticipated that the impact of these temporary factors will subside, leading to a more stabilized inflation environment in the second half of the fiscal year.

In light of these factors, the RBI has made adjustments to its CPI projection for the full fiscal year 2023-24 (FY24). The central bank has revised its initial projection from 5.1 percent to 5.4 percent, acknowledging the potential for inflation to trend slightly higher due to the factors discussed above. This adjustment reflects the central bank’s commitment to monitoring and managing inflationary pressures while maintaining its goal of price stability and sustainable economic growth.

In conclusion, the CPI inflation rate for June 2023 saw a rise to 4.8 percent from 4.3 percent in the previous month, primarily driven by an increase in food inflation caused by uneven monsoon patterns and heatwave conditions. The RBI has made revisions to its inflation projections for the near term, highlighting the potential upside risks from food prices.

However, the central bank maintains the view that the recent uptick in inflation is likely temporary and will likely fade in the latter half of the fiscal year. As a response to these developments, the RBI has adjusted its full-year CPI projection for FY24 from 5.1 percent to 5.4 percent. This approach underscores the RBI’s commitment to maintaining price stability and managing inflation while supporting sustainable economic growth.

After a delayed onset, the Indian monsoon has shown signs of improvement, with a shift from a deficit in June to a surplus of 5 percent above the normal level in July. This change in weather patterns has brought some relief to agricultural activities and water resources.

However, the India Meteorological Department (IMD) has issued forecasts indicating that August might experience below-normal rainfall, falling short of 94 percent of the Long Period Average (LPA). This prediction raises concerns about the potential impact on agriculture, particularly kharif sowing.

The uneven spatial distribution of rainfall, if it persists, could have adverse effects on the planting and growth of crops during the kharif season. Insufficient rainfall in certain regions may lead to reduced yields and supply shortages, potentially contributing to inflationary pressures, particularly in food prices. As seen historically, fluctuations in monsoon patterns can significantly influence agricultural output and subsequently impact overall inflation levels.

Another factor contributing to potential inflationary pressures is the recent increase in international crude oil prices. These price hikes have been attributed to supply cuts implemented by OPEC+ countries, which have led to a reduction in global oil supply.

As India is a net importer of oil, any significant rise in crude oil prices can exert upward pressure on imported inflation. This could have a cascading effect on various sectors of the economy, including transportation and manufacturing, leading to higher production costs and potentially translating into higher consumer prices.

In summary, while there has been a turnaround in monsoon patterns with improved rainfall in July, the prediction of below-normal rainfall for August, along with the spatial distribution of rainfall, raises concerns about its potential impact on agricultural output and subsequent food inflation.

The recent surge in international crude oil prices due to supply cuts from OPEC+ countries adds another layer of inflationary pressure, especially through imported inflation. Both of these factors warrant close monitoring by the Reserve Bank of India to ensure effective policy responses to manage inflation and maintain overall economic stability.

The current economic scenario in India is marked by a mix of concerning and reassuring factors. While there are concerns about food inflation, there is a comforting element in the ease of Wholesale Price Index (WPI) inflation. The deflation in WPI, coupled with the softness in global commodity prices, could potentially offset some of the rising inflationary pressures, albeit with a delay.

Additionally, the moderation in core inflation, which is reflected in the decline of Core Consumer Price Index (CPI) to 5.1 percent in June 2023, provides a sense of relief. This moderation is attributed to the impact of past transmission on the real economy.

Studies suggest that headline inflation tends to follow the trend of core CPI, implying that inflation dynamics are under control. However, the Reserve Bank of India (RBI) remains concerned about the impact of these shocks on household inflation expectations.

The Monetary Policy Committee (MPC) statement indicates that these shocks are likely short-term in nature and can be overlooked for the time being, unless recurring incidents of food price shocks emerge that could anchor inflation expectations. Monitoring the temporal and spatial distribution of rainfall, along with the potential occurrence of an El Niño event, remains crucial.

Despite challenges, India’s economic activity continues to display resilience, as evidenced by indicators like GST collections, corporate and income tax revenues. Urban demand remains strong, with sustained growth observed in domestic air passenger traffic and household credit.

The recovery in kharif sowing and rural incomes, along with positive sentiment in the services sector and consumer outlook, should support household consumption. While high-end consumption and government capital expenditure remain robust, lower-end domestic demand and exports are subdued.

The government’s emphasis on capital expenditure, increased capacity utilization in manufacturing, moderation in commodity prices, and healthy credit growth contribute to growth prospects. The RBI maintains its real GDP growth projection at 6.5 percent for the fiscal year 2023-24. However, risks to this outlook include weaker global demand, geopolitical tensions, and the potential impact of developing El Niño conditions.

To manage excess liquidity resulting from the withdrawal of Rs 2000 notes, the RBI has directed scheduled banks to maintain an incremental Cash Reserve Ratio (CRR) of 10 percent on the increase in their net demand and time liabilities (NDTL) within a specific timeframe.

This move aims to absorb surplus liquidity. While this decision has led to some short-term concerns for banks, its impact on individual banks needs to be evaluated. The RBI plans to review this decision by September 8, considering the systematic liquidity situation in anticipation of the festive season.

The RBI’s focus remains on keeping inflation expectations anchored at its primary target of 4 percent. The central bank appears to be more concerned about uncertainties surrounding the inflation outlook than about growth. Due to the recent uptick in food inflation, expectations of a rate cut have been pushed further, with a potential rate cut anticipated in the first quarter of fiscal year 2024-25, contingent on data.

In conclusion, India’s economic landscape presents a complex picture, with various factors influencing inflation and growth. The RBI is closely monitoring these developments to ensure price stability and sustainable economic expansion.