Opinion
MPC needs to weigh slow growth, turbulence in global markets
Summary
- Expectation of monetary policy easing in the developed world is gathering pace but in our view, domestic inflation trajectory is likely to be the dominant factor in determining the tone and outcome of the August MPC meeting as the balance of risks will likely remain towards inflation control.
The macro backdrop for August monetary policy committee (MPC) meeting remains constructive with lower global commodity prices, expectations of more monetary policy easing in the developed markets, resilient domestic growth, and a fiscally conservative budget. However, the indirect effects of the possible slowing down of global growth momentum and widespread turbulence in global asset markets would have to be carefully weighed by the committee.
Disinflationary trends are gradually getting entrenched globally with global commodity prices declining ~6% between the June and August RBI MPC meetings. Expectation of monetary policy easing in the developed world is gathering pace but in our view, domestic inflation trajectory is likely to be the dominant factor in determining the tone and outcome of the August MPC meeting as the balance of risks will likely remain towards inflation control.
The headline CPI, which was consistently declining in 2024, deviated from that trend in June and went above the 5% mark as strong heatwaves pushed up vegetable prices. The July headline CPI would benefit from favourable base effects but could still be ~3.8%YY, this is ~50bps higher than our initial estimate.
Read more: The US Fed’s actions can inform RBI policy but mustn't drive it
The cumulative upside surprise in inflation over June and July might prompt the Reserve Bank of India (RBI) to marginally revise higher its average CPI forecast for FY25 from the 4.5% mentioned during the June policy. However, the monsoon is progressing well, and vegetable prices have started reversing from their summer peaks. This could imply that the RBI would not feel the need to revise its 9-12 months ahead quarterly inflation forecasts.
We do not expect the MPC to change the “withdrawal of accommodation" stance or policy rate in the August meeting as it would “look through" both the recent short-term spike in vegetable prices and the favourable base effect-led decline in headline inflation in July/August.
The cautious policy stance of “withdrawal of accommodation" is also likely to continue in an uncertain environment where the RBI might want to refrain from providing strong forward guidance through stance change. However, comments around the following issues could potentially affect the market’s expectation about the future policy path.
Read more: Sebi's proposed new asset class is just the ticket for affluent Indians
If the RBI raises the FY25 average CPI forecast then it could push back rate cut expectations, though much will also depend on the CPI forecast trajectory too. A strong reiteration of the RBI’s commitment to durably align the headline CPI to its medium-term target of 4% would imply that the RBI might be patient to start embarking on a rate-easing journey.
A new RBI paper has recently updated the estimates for neutral rate to 1.4-1.9%, compared to 0.8-1.0% earlier. While neutral rate is a theoretical construct and not an explicit target for monetary policy, any signs of the MPC’s views on the impact of the revised neutral rate on their decision making, would be closely watched.
RBI’s assessment of the financial stability parameters could be an indication of the need and space to persist with the current policy stance. Our analysis suggests that the financial conditions (as a combination of different asset markets) might still be considered easy by historical standards.
One example of this is the substantial improvement in banking system liquidity which is leading to softening of overnight and short-term rates. Although weighted average real lending rates have moved up, they are still below their previous cycle peaks. However, the MPC could be mindful of the contagion from the recent global financial market turbulence as it could theoretically tighten financial conditions in India, too.
The RBI governor in the past has been unambiguous in stating that India’s monetary policy decisions would be determined more by domestic growth-inflation conditions rather than guided by the “follow the Fed" principle. With more central banks likely entering the rate-easing cycle aggressively (our US economists now expect the Fed to cut by 50bps each in the September and November meetings), any subtle change in the RBI view could have market impact.
Read more: Stock market crystal ball gazing: Where are derivatives headed?
Our current growth-inflation forecast trajectory suggests that the RBI could hold on to policy rates for now with the first repo rate cut deferred till April 2025. This along with RBI’s neutral rate estimate reaffirms our view of a shallow rate cut cycle (~50bps) unless there is a sharper disinflation in India following global cues.
Dr. Samiran Chakraborty, managing director, Chief Economist, India, Citigroup Global Markets India Pvt. Ltd.
