For RBI, the recipe for rate cuts is not ready yet

Also Read: RBI keeps repo rate unchanged at 6.5%

Inflation measured via consumer price index (CPI) has dropped to 5.1% in the first two months of 2024 from 5.7% in December. Core inflation too, has tapered to 3.4% from 3.8% in December. Yet, the projection for FY25 inflation remains unchanged at 4.5%, which would have been the guiding figure for the MPC to maintain a status quo.

While food inflation has also come down between December and February, it is still high at 7.8%. More importantly, it continues to remain volatile—from December it fell in January, but rose again in February. The monetary policy statement notes, “Headline inflation has come off the December peak; however, food price pressures have been interrupting the ongoing disinflation process, posing challenges for the final descent of inflation to the target".

Also Read: RBI Policy: Why does the market look disappointed with RBI MPC outcome?

Even beyond inflation, the continued strong growth momentum and optimism, possibly means a rate cut could be unwarranted. Consider the recently released HSBC India manufacturing PMI. It has risen sharply to 59.1 in March, a 16-year high, up from 56.9 in February and 56.5 in January. The improvement has come across all areas of manufacturing such as new orders, raw material inventory stocking and more significantly, the fastest increase in new export orders since May 2022.

In the post-policy statement, the RBI governor Shaktikanta Das points out, “Robust growth prospects provide the policy space to remain focused on inflation and ensure its descent to the target of 4%."

Recall that independent member Prof. Jayanth Varma had stated among his reasoning for voting for a rate cut in the February meeting: “It is true that economic growth is holding up well, but there is no evidence at all that the economy is overheating."

With the latest PMI, this, possibly, does not hold true anymore.

Surprisingly, the committee doesn’t seem to be much worried about the recent spike in crude oil prices and simply says, “The recent firming up of international crude oil prices warrants close monitoring." Brent crude prices are near $90 a barrel now, representing an increase of almost 16% in two months.

Paradoxically, the state-run oil marketing companies cut petrol and diesel prices by ₹2 per litre on 14 March, just ahead of the upcoming general elections. If the crude prices remain firm, pump prices would, in all likelihood, go up after the elections and upset the inflation trajectory.

Despite the rate not being cut, borrowers still have something to cheer about as the weighted average call money rate (WACR) has come down in recent weeks. As per the RBI Database, weekly WACR has come down from 6.72% for the week ending 2 February to 6.52% by 15 March, aided by RBI’s liquidity infusion. WACR had stayed above the 6.7% mark since September, adding another 20 bps to the effective policy rate.

Independent member Prof. Ashima Goyal had raised this in her February statement, “The daily WACR has often exceeded the repo rate in the past few months…. measures to ensure the WACR largely stays at the repo rate are required."

The governor acknowledged this in his statement today: “The WACR exhibited a softening biasand has hovered near the repo rate since the last policy meeting."

But the decision may have also been impacted by the US Fed's stance as it has not yet made any rate cut despite having indicated its willingness. A rate cut carries the risk of flight of capital impacting the forex market and destabilising the Indian rupee.

In a somewhat different context, the governor referred to this today, “Worsening debt situation in advanced economies can generate spillovers for emerging market economies in the form of swings in capital flows and volatility in financial markets."

The Indian economy appears well placed with forex reserves of $645.6 billion by 29 March, an all-time high, which provides sufficient cushion to absorb any pressure on rupee. As such, any turbulence now would be insignificant as compared to the volatility seen when the US Fed raised rates to 5.5% from near zero. The RBI had successfully managed to defend the rupee with manageable depletion of its forex reserves to $524 billion in October 2022 from $642 billion in September 2021.