RBI won’t waver in its focus on taming retail inflation

Signs of price stability, in food especially, may lead to shallow rate cuts from the second half of 2024-25

is chief economist at CareEdge.

The decision of the Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) to leave the policy rate unchanged in the last meeting was on expected lines. RBI also maintained its stance of ‘withdrawal of accommodation,’ as it is committed to bringing down consumer price index (CPI)-based inflation to its 4% target on a durable basis. RBI governor Shaktikanta Das highlighted that healthy economic growth has given RBI room to unwaveringly focus on price stability.

While CPI inflation has moderated to 5.1% in the last two months, it remains above RBI’s 4% goal. Core inflation (excluding food and fuel) has slipped below 4%, with continued disinflation in the services sector. The main concern for the central bank is persistently high food inflation—7.4% in February. Specifically, very high inflation in items of daily consumption like vegetables (30%) and pulses (19%) could result in upward pressure on household inflationary expectations. As per the latest RBI survey, the household perception of current inflation moderated to 8.1% in January 2024 from 8.9% in July 2023. But one-year-ahead inflation expectations remain high at 10%. With a normal monsoon expected this year, we can expect further moderation in food inflation. However, caution is warranted, given that in the last few years, we have seen increased climate risks, with an adverse impact of that on domestic and global food prices. India’s Meteorological Department has warned of more heat waves than usual this year. This increases upside risks for food inflation, specifically for vegetables and fruits. Low water reservoir levels are another concern. Hence, a normal monsoon with good spatial distribution will be very critical for a moderation in food inflation. RBI has maintained its average CPI-based inflation projection of 4.5% for 2024-25, as against an estimated 5.4% in 2023-24.

Apart from food inflation, concerns stem from geopolitical rifts and the ensuing risks of supply-side bottlenecks. While overall global commodity prices are likely to remain benign due to weak global demand, one cannot ignore supply-side risks. We have seen global trade disrupted by the Red Sea crisis and Brent crude oil prices rise by a sharp 18% in the year so far.

On the global front, another risk that the governor aptly highlighted is rising levels of public debt. For advanced economies, public debt-to-gross domestic product (GDP) has risen sharply to 112% and for emerging economies to 67% in 2023, according to the International Monetary Fund. The backdrop of high public debt, high interest rates and low growth is making debt sustainability a challenge. Advanced economies that have enjoyed low interest rates in the past are now facing a situation of higher for longer interest rates. This will have severe implications on their interest payment burden. For instance, for the US government, net interest payments are projected to cross 20% of revenue by 2032 from 9.7% in 2022, as per the US Congressional Budget Office. Similarly, for the UK, the government’s interest expenses have already doubled from 5.4% of revenue in 2020 to 11% in 2022. Das has highlighted that the worsening debt situation in advanced economies can pose risks for emerging economies by way of swings in capital flows and financial market volatility.

Even with a global slowdown, India’s external situation remains comfortable. Merchandise exports, which had been hit by the global slowdown, are already showing improvement. Supported by healthy service exports and strong remittances, we are expecting India’s current account deficit at a benign 0.7% of GDP in 2023-24 and around 1% in 2024-25. There have been strong foreign institutional investor inflows in the last fiscal year and the trend is likely to continue this year, with the inclusion of Indian government bonds in global indices. India’s foreign exchange reserves are at a comfortable $645 billion. As far as domestic growth is concerned, RBI remains optimistic, with a GDP growth projection of 7% for 2024-25. High frequency economic indicators like the purchasing managers’ index, GST collection, auto sales and bank credit growth indicate a healthy growth momentum. However, a broad-based pick-up in consumption demand remains critical. Rural demand has been feeble but is showing signs of improvement, going by fast-moving consumer goods and two-wheeler sales data. Based on the assumption of normal monsoon rainfall, we can expect consumption growth to improve.

The other critical goal is a meaningful pick-up in private investment. It has increased in sectors like steel, cement, petrochemicals, automobiles, aluminium and renewable energy. The order books of capital goods companies have also grown sharply in the last fiscal year. Moreover, data from the Centre for Monitoring Indian Economy on project investment has been showing the private sector’s growing intent to invest. Hence, we can expect the private capital expenditure cycle to accelerate.

This brings us to the question of whether RBI will cut policy interest rates this fiscal year. If CPI inflation continues to moderate and there is respite on food inflation, specifically, we can see rates being cut by a shallow 50 basis points in two tranches starting from the third quarter of 2024-25. RBI will be watching the actions of the US Federal Reserve. Given India’s comfortable external position, however, the critical factor influencing its decision will be domestic inflation.