Opinion
RBI stays the course in pragmatic monetary policy
Summary
- In June, it was about creating a distinction between the potential rate cut cycle in the developed markets and our approach to the same. August MPC was more about a crash course on food inflation and the need to vanquish it before considering policy normalization.
The latest meeting of the monetary policy committee (MPC) was held in the background of a sudden spurt in volatility in global financial markets. Weaker-than-expected US employment data right after the July Fed meeting, unwinding of the massive yen carry trade followed by a quick appreciation of the dollar-yen pair and sharp correction in the world equity markets raised fears of a US recession, and raised the clamour for a faster-than-expected interest rate easing in the US.
As result, global bond yields have plunged since the Fed's July meeting, with 10-year US treasury yield falling by approximately 37 bps to touch a low of 3.78% on 5 August, before recouping to 3.90%. The futures market is pricing more than 110 basis points of cumulative rate cuts by the Fed by December 2024.
In light of these developments, bond market participants who were hoping for some positive signals from the RBI on potential rate cuts, were thoroughly disappointed as the RBI governor not only sounded a bit hawkish, but also gave no indication on the timeline of a potential rate cut.
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This was similar to the June meeting outcome in more than one way. Both times, the MPC voted 4-2 to keep the policy rate unchanged at 6.5%, with two independent members demanding a rate cut. Both times, the MPC voted 4-2 to keep the policy stance unchanged with the same two independent members calling for a change to neutral. The FY25 real GDP growth projection was maintained at 7.2%, while FY25 average inflation forecast was marginally revised up to 4.58% from the earliest estimate of 4.5% in June MPC.
But this is where the similarities between the two MPC meetings probably ended, in our view. In August, the RBI governor took the opportunity to deliver some important messages to the bond market on food inflation, core inflation and stability in financial markets.
Food inflation in focus
On Thursday, the governor spent considerable time on food inflation. He emphasized that while the RBI targeted the headline inflation, food inflation, with its 46% weight, was an important part of the overall inflation management due to its direct link with the household inflation expectations.
In June, food inflation rose to 9.36%, while average food inflation in the 12 months to June 2024 was at 8.75%. Further, food inflation was responsible for almost 3/4th of total inflation. This is significantly higher and sticky. No wonder the RBI must remain vigilant on food inflation.
Also read | MPC needs to weigh slow growth, turbulence in global markets
More importantly, he sought to create a distinction between sticky headline inflation and falling core inflation by reiterating that RBI can’t and shouldn’t be complacent on falling core inflation. He feared that unanchored food inflation may have potential to spill over to core inflation leading to a reversal in core inflation and sticky headline inflation down the road.
It is noteworthy that while the June 2024 headline inflation unexpectedly jumped to 5.08%, Q1 headline inflation averaged 4.9% and Q2 was revised up to 4.4% in August MPC, from 3.8% in June MPC. This is a significant upward revision, in our view.
Monsoon progress acknowledged
The governor acknowledged the ongoing progress of monsoon so far, but prefers to wait for a tangible decline in food inflation on durable basis before feeling comfortable. This conservative approach is totally understood and appreciated amid the ongoing weather-induced volatility in the global food supply and vagaries in different categories of food prices.
On the importance of financial stability, the RBI governor highlighted that while the overall financial sector remained healthy and stable in India, there were pockets of concerns that warranted higher vigilance. He highlighted four such areas of concerns and focused on resolving them. He reiterated that financial market stability was prerequisite to higher investment and stronger economic growth.
Also read | The US Fed’s actions can inform RBI policy but mustn't drive it
Overall, it was a pragmatic and steady-as-she-goes policy outcome, with an acknowledgement of some harsh reality that the RBI is facing and preparing the market to handle them one by one. In June, it was about creating a distinction between the potential rate cut cycle in the developed markets and our approach to the same. August MPC was more about a crash course on food inflation and the need to vanquish it before considering policy normalization at a later date subject to the growth inflation dynamic. It is a turning wicket. Thank goodness we have the experienced batting line-up.
Disclaimer: Mr Dhawal Dalal is the President & Chief Investment Officer – Fixed Income of Edelweiss Asset Management Limited (EAML) and the views expressed above are his own.
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