Monetary policy: Things to watch out for in the coming months

The RBI Monetary Policy Committee (MPC) goes into the June meeting with global disinflation running into last mile challenges and global monetary policy cycle starting to become asynchronous.
The RBI Monetary Policy Committee (MPC) goes into the June meeting with global disinflation running into last mile challenges and global monetary policy cycle starting to become asynchronous.

Summary

  • A wait-and-watch policy in June will be ideal to monitor and evaluate the impact of the Union budget, bond index inclusion, monsoon outturn and US FOMC decision.

In what is expected to be a status quo policy, the main takeaway from the Reserve Bank of India’s (RBI) June policy will be any signals for the start of the rat-cut cycle. 

However, it is unlikely that the RBI will sound dovish, just yet. In fact, much of the macro construct remains broadly similar to the April policy. Growth remains steady which will continue helping the RBI to focus on the 4% inflation target. 

Quite a few events including the Union Budget, Bond Index inclusion, monsoon outturn, US Federal Open Market Committee (FOMC) decision and other major central bank policies will play out over the next few months. A wait-and-watch policy in June will be ideal to monitor and evaluate the impact of these events.

Also read | RBI Policy: What changed since the last RBI policy meeting?

The RBI Monetary Policy Committee (MPC) goes into the June meeting with global disinflation running into last mile challenges and global monetary policy cycle starting to become asynchronous. 

The European Central Bank is expected to start its rate-cut cycle as soon as June while the Bank of Japan remains on the edge of rate hikes. The US Fed’s rate-cut cycle remains some time away, possibly starting from September or November. Global growth outturns have been much better than expected over the past few quarters but concerns on durability will linger on. the impact of positive growth impulses on commodity prices will also need to be monitored.

Inflation in check

Domestic inflation has come off durably below 5% and has been panning out as per the RBI’s expectation. Core inflation at around 3% will continue to provide comfort to the MPC though we expect it to pick-up over the next few months. 

The IMD predicts the monsoon to be above normal with La Nina conditions developing later in the season. This bodes well and will provide greater clarity on the food inflation trajectory. This is crucial for inflation moving durably towards the 4% mark and squashing concerns on the last mile disinflation worries. However, based on the current trends we estimate inflation to average around 4.5% and unless there is a sharp disinflation in food prices, a more durable move towards 4% seems possible only in FY2026.

Also read |  MPC meeting: Inflation elephant hogs attention; interest rate change unlikely

GDP growth, as confirmed by the prints of around 7.5-8%, remains quite strong while GVA growth around 6.5-7% paints a much more muted picture. Activity indicators continue to signal robust near-term growth prospects. Robust growth prints coupled with benign core inflation prints poses questions on where the RBI lies on the monetary policy cycle. 

The RBI will continue to closely evaluate the output gap. Few MPC members have opined that the output gap has closed (though that should not necessarily imply inflationary pressures risks). Potential GDP should improve given the supply-side focus of the government along with improvement in financial sector and corporate balance sheets. GDP growth is likely to average around 7% in FY2025 with investments remaining one of the primary growth drivers. An above-normal monsoon and modest improvement in rural demand could add to the growth prospects.

Between inflation and growth

A central bank typically oscillates between concerns on inflation and concerns on growth. For the RBI, the support from a strong growth trajectory provides space to focus on pushing inflation durably towards the 4% target. While the RBI does not have to be in sync with the Fed, a delayed rate-cut cycle by the Fed helps in aligning with global rate cycles too without compromising on the domestic priorities. 

We continue with our long-held call that the RBI will continue to maintain repo rate at 6.5%, at least, until Q3FY25. The rate cut cycle will be shallow unless concerns on growth far outweigh concerns on inflation. The June policy will most probably continue with the RBI remaining on a wait-and-watch mode.

The author is chief economist at Kotak Institutional Equities. The views and opinion expressed in the column are personal and do not necessarily reflect the opinion of the organization or the Kotak Group.

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