Growth-inflation dilemma: Will RBI maintain its status quo on rates?

In its fourth bi-monthly monetary policy meeting for FY2024 that was held in October 2023, the Monetary Policy Committee (MPC) had expectedly paused unanimously on the policy rate and maintained its stance with a vote of 5:1. As anticipated, the tone was rather hawkish, reiterating the focus on bringing down inflation to the 4.0 per cent medium term target. The chief surprise was the discussion around the need to consider open market operations (OMO) sales to manage liquidity, which led to a surge in the yields of Government securities.  

In the ensuing weeks, there has been some good news on the inflation front. The headline CPI inflation print had already cooled from 7.4 per cent in July 2023 to 6.8 per cent in August 2023, before the MPC had met last. It has eased further to 5.0 per cent in September 2023 and 4.9 per cent in October 2023, partly benefitting from the enhanced LPG subsidy. Even as the spike in tomato prices expectedly reversed, and a seasonal downtrend in many vegetable prices has set in with the onset of the winter, rising onion prices have wrought fresh concerns. 

The 2023 monsoon was erratic, and the first advance estimates of the kharif crop portend lower output for all the major groups of crops. Looking ahead, reservoir levels remain well below the year-ago and historical averages. The sowing of rabi crops also trailed the year-ago levels in the post-Diwali week. The outlook for foodgrain prices appears sombre, although some of the bad news has crept into the October 2023 CPI print already. 

The CPI inflation would climb over the next two months to 5.6 per cent by December 2023. Thereafter, it would print in a wide range for the subsequent two quarters, before a favourable base effect cools the same temporarily in Q2 FY2025. We foresee CPI inflation at 5.3 per cent in FY2024, slightly lower than the MPC’s estimate of 5.4 per cent. If the next monsoon is relatively normal, inflation may cool to 4.7 per cent in FY2025, while remaining moderately higher than the 4.0 per cent target. 

On the growth front, the MPC will have the GDP growth print for Q2 FY2024 when it meets in December 2023. A normalising base and the uneven monsoon are expected to dampen GDP expansion to 7.0 per cent in Q2 FY2024 from 7.8 per cent in Q1 FY2024. However, we aver that the pace of GDP growth in this quarter will exceed the MPC’s October 2023 projection of 6.5 per cent. 

Looking ahead, the prognosis for GDP growth is less optimistic for H2 FY2024. The base effect will continue to play spoil sport, optically moderating growth in certain sectors. Moreover, the bleak agri outlook, cumulative impact of monetary tightening and weak external demand will pose headwinds. Additionally, two other factors are expected to moderate the momentum in value-added growth and/or dampen sentiment. These are, narrowing differentials with year-ago commodity prices, and the possible slowdown in momentum of Government capex as we approach the Parliamentary Elections. We fear that GDP growth in H2 FY2024 will be sub-5 per cent. As a result of this, we project FY2024 GDP growth at 6.0 per cent, lower than the MPC’s projection of 6.5 per cent. 

In this domestic inflation-growth context, with geo-politics adding to uncertainty and perpetuating listless global growth, we suspect that an extended pause from the MPC lies ahead. In our view, further monetary tightening is certainly not warranted at this stage, given the continued transmission of the past rate hikes. The bar for another rate hike would be quite high, requiring inflation to appear set to persistently exceed the MPC’s forecasts for at least two quarters amid evidence of transmission of pressures to core inflation.  

At the same time, the focus on bringing inflation back to 4.0 per cent suggests rate cuts are distant. We expect an extended pause on the policy rate and an unchanged stance through FY2024. Thereafter, a shallow rate cut cycle, limited to 50-75 bps, may commence only in August 2024. 

Simultaneously, the FOMC’s latest minutes have doused hopes of an early rate cut in the US. Our belief is that Central Banks will err on the side of caution before declaring victory on inflation and easing rates, unless there is an exogenous shock to growth in the offing. 

This brings us to the surprise announcement that accompanied the last policy review; the possibility of OMO sales to mop up excess liquidity. Liquidity conditions have largely remained tight since the last policy meeting in early-October 2023, barring intermittent respite on some occasions, as reflected in the sustained large borrowings via the Marginal Standing Facility as well as the elevated levels of the Weighted Average Call Rate vis-à-vis the repo rate. Interestingly, this tightness has prevailed despite G-sec redemptions worth Rs. 1.1 trillion in November 2023 so far (up to Nov 28, 2023) suggesting that the GoI’s cash balances have remained elevated.  

Although some cooling is likely in early-December 2023, systemic liquidity is set to tighten significantly thereafter in the second half of the month owing to the concurrent occurrence of advance tax outflows and GST payments, unless these are offset by large expenditure during the same period. Consequently, until India starts witnessing large capital inflows ahead of the bond index inclusion, OMO sales may not materialise. 

Views are personal. The author is Chief Economist, Head- Research & Outreach, ICRA 

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