Another pause is on the cards
The Reserve Bank of India's monetary policy committee is expected to maintain status quo on policy rates in its June review, despite softer-than-expected inflation and above-expectations growth. While excess unseasonal rain may impact growth, healthy reservoir levels and the absence of El Nino until the second half of the monsoon season may not affect kharif sowing significantly. However, the possibility of a subsequent deficiency in monsoon rainfall affecting food inflation may pose an upside risk to the consumer price index inflation trajectory in the second half of fiscal year 2024.
PremiumIn April, the monetary policy committee (MPC) surprised the markets with a pause on policy rates while modifying the wording of the policy stance to sharpen the focus on the 4% retail inflation target. It was emphasised that the pause was for that meeting only. However, a status quo appears to be on the cards in the June policy review as well.
Since the MPC last met, inflation has eased, and growth has printed well above expectations. The softer-than-expected inflation outlook for Q1 FY24 may warrant a mild downward revision in the MPC’s FY24 consumer price index (CPI) inflation forecast of 5.2%. It would also aggravate the calls for an early pivot to rate cuts. However, the lurking fear of developing El Nino conditions and its impact on rainfall and food inflation may dissuade the committee from relenting on either.
The CPI inflation moderated from 6.4% in February to an 18-month low of 4.7% in April amid a favourable base effect. Moreover, above-normal rainfall kept a check on the seasonal rise in prices of some food items. We project the average CPI inflation at 4.7% for Q1 FY24, undershooting the MPC’s projection of 5.1% by a solid ~40bps.
With healthy reservoir levels and El Nino expected to materialise only in the second half of the monsoon season, kharif sowing may not be significantly impacted. However, any subsequent deficiency in monsoon rainfall could affect kharif yields and winter sowing, and thereby food inflation, which poses an upside risk to the CPI inflation trajectory in H2 FY24.
Moreover, the higher-than-expected GDP growth print for Q4 FY23 and full-year FY23 would provide some comfort to the MPC and reinforce its decision to pause, notwithstanding the unevenness across the sectors and expenditure aggregates. This would also imbue confidence in the committee’s growth estimate of 6.4% for FY24.
The momentum of economic activity in Q1 FY24 is likely to be impacted by excess unseasonal rain, as reflected in the muted growth in eight core industries’ output as well as other high-frequency indicators for April. Further, the sharp 12.7% contraction in merchandise exports and the moderation in service export growth to a 23-month low of 7% is likely to weigh on GDP growth during the quarter, despite the favourable base. However, producers’ margins will likely see substantial relief in Q1 FY24, with commodity prices much lower than the peaks seen in June-July 2022 in the aftermath of the Russia-Ukraine war.
Given the near-term outlook, as well as the ongoing passthrough of previous rate hikes, we believe there is no need for further rate hikes at the current juncture. At the same time, the impending risks to the CPI inflation and the focus on the 4% target would imply that a pivot to rate cuts appears quite distant.
The commentary around the policy stance and liquidity management will be keenly watched in the June policy. RBI’s decision to withdraw the ₹2000 notes from circulation by 30 September is likely to push up bank deposits and durable liquidity during the first half of the fiscal. In addition, relatively favourable expectations for India’s balance of payments position, vis-à-vis six months ago, also augur well for liquidity. Although these are at odds with the withdrawal of accommodation stance, the upside risks to inflation would prevent MPC from changing its stance in the upcoming policy, amid its criteria of a ‘decisive moderation in inflation and the propensity to align with the target’.
Aditi Nayar is chief economist of head of research and outreach at Icra Ltd.
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