Waiting for summer

Fear of inflation keeps RBI from cutting rates. Poor monsoon, oil prices could throw spanner in works

THE RESERVE BANK of India’s ( RBI) non- action on April 5 was par for the course. With growth stronger than expected and inflation above target, the market expected the RBI to stay put on rate action as well as its stance.

The second advance GDP estimate released in February had shown the economy ticked at over 8 per cent in the first three quarters, lifting the fiscal’s growth to 7.6 per cent. High- frequency data shows the momentum has continued into the fourth quarter. The composite Purchasing Managers’ Index ( PMI) for March at 61.8 was in a very strong expansion zone. Direct and indirect tax collections have exceeded targets with the solid performance continuing in March. This highlights the resilience of non- farm sectors, particularly construction, manufacturing and financial services. Agricultural growth, though, was an anaemic 0.7 per cent in 2023- 24.

Viewed from the expenditure side, GDP growth has been largely investment- driven with private consumption growth trailing GDP. That said, private consumption, vital for balanced and sustainable growth, will remain a key monitorable.

CRISIL expects India’s GDP growth to moderate to 6.8 per cent in the current year. The transmission of the RBI- effected rate hikes between May 2022 and February 2023 is underway and is likely to modestly weigh on demand in 2024- 25. Regulatory actions to tame unsecured lending will also have a bearing on credit growth. Additionally, a lower fiscal deficit will mean a lower fiscal push to growth. Despite the expectation that growth and inflation would moderate in 2024- 45, the RBI has been wary of declaring an early victory. Governor Shaktikanta Das noted that the last leg of disinflation has proved to be a difficult one across the world. “Strong growth prospects provide the RBI policy space to remain focused on inflation and ensure its descent to the target of 4 per cent,” he said.

Mint Road retained its February forecast of 7 per cent GDP growth in 2024- 25, marginally higher than CRISIL’S expectation. Inflation is projected to drop to 4.5 per cent assuming a spell of normal monsoon and

High food inflation is likely to have contributed to weak consumption demand since it erodes the discretionary spending of households. The government’s free foodgrain programme does provide a cushion to low- income households, but an overall reduction in food inflation will bring bigger relief. Expectation of normal monsoons, healthy agriculture and lower food inflation will be positive for rural consumption this fiscal.

range- bound crude oil prices.

The India Meteorological Department believes that the El Niño’s impact will fade by the second half of the year and La Niña conditions, associated with abundant rains will set in. This will help cool food prices, which has been the key worry. Food inflation has averaged 7.4 per cent in the first 11 months of this year, whereas non- food inflation was only 4.1 per cent.

The latest print for February showed food and non- food inflation were at 8.7 per cent and 2.9 per cent respectively. Core inflation, computed after removing food and fuel from the headline inflation, was at a benign 52week low of 3.4 per cent. Within food, foodgrain inflation softened somewhat, but vegetables inflation has stayed high and volatile, flaring up to 30.2 per cent in February from 27.1 per cent in January.

The RBI can generally look through vegetable inflation since it is volatile. Moreover, vegetables have short crop cycles and their prices correct fairly quickly. However, vegetable price shocks have been quite persistent this time, keeping inflation in this category high. The bigger worry has been foodgrain inflation which, despite softening, was still at a high of 9.8 per cent in February. While central bank policy moves cannot bring down supply shock- driven food inflation, it can prevent high prices from travelling to nonfood inflation. Especially when growth is high and food inflation persistent, as in India.

Another worry stemming from food inflation is that it hurts the lower income deciles more than the upper ones. Our calculations show in February, the bottom 20 per cent of the urban population faced 5.5 per cent inflation compared with 4.7 per cent faced by the top 20 per cent since food has a higher weight in their consumption basket. The pattern in rural areas was similar. This should correct with softening of food inflation in 2024- 25.

High food inflation is likely to have contributed to weak consumption demand since it erodes discretionary spending of households. The government’s free foodgrain programme does provide a cushion to low- income households, but an overall reduction in food inflation will bring bigger relief. Expectation of normal monsoons, healthy agriculture and lower food inflation will be positive for rural consumption this fiscal.

After food, let’s turn to fuel. In our base case scenario, we do not expect any significant risk to fuel inflation since crude prices will likely be $ 80- 85 per barrel in 2024- 25. However, the recent surge in crude prices in an uncertain geopolitical setting does raise some concern.

The Federal Reserve and the European Central Bank have not been in a hurry to cut rates since headline and core inflation remain high despite the softening trend. In its March meeting, the Fed hinted it would cut interest rates in the coming months. S& P Global believes inflation will likely remain above the Fed’s target of 2 per cent through 2024 reflecting persistently higher service price inflation, even as goods prices ease modestly. We expect the Fed and ECB to initiate rate cuts in June.

To be sure, India’s monetary policy decisions are based more on domestic conditions and inflation dynamics than on US rate moves. But in an interconnected world, rate cuts by systemically important central banks do nudge rates cuts in emerging markets. S& P Global expects Latin American emerging market central banks that have already cut rates to continue with the same through this year. Central banks in emerging Asian economies will likely start cutting rates in the second half.

The other good news on the rate front is that fiscal policy is unlikely to come in the way of rate cuts due to improved coordination between fiscal and monetary policy. The interim budget focused on fiscal consolidation by aiming to cut the fiscal deficit to 5.1 per cent of GDP this year. Going by experience, the budget post the elections is unlikely to change the fiscal stance if the current government returns to office. The overall macro environment is turning conducive for central banks to begin cutting rates by the end of summer. For India, though, a poor monsoon, extreme weather events and crude oil prices could throw a spanner in the works.

The writer is Chief Economist, CRISIL Limited