With food inflation remaining sticky, it is not surprising that the Monetary Policy Committee (MPC) chose to retain the key policy rate at 6.5%, even though core inflation has softened for the 11th straight month since June 2023 and services inflation has moderated to historic lows. The relatively strong growth trends also allow it time to pursue its objective of taming inflation. The Reserve Bank of India (RBI) has, in fact, upped its gross domestic product (GDP) growth forecast for the current year to 7.2% from 7%, despite a high base of 8.2%. Assuming the monsoon is a normal one, inflation for the current year has been forecast at 4.5%. However, the trend in prices of pulses and vegetables is uncertain, while core inflation may be impacted if companies increase prices and wages go up.
Two external MPC members believe policy rates should be cut now and that stance should be changed to withdrawal of accommodation. However, going by the RBI’s tone, it is expected to wait until it is confident that inflation will sustain at 4%. A rate cut in August seems unlikely, but looks possible in October, if the rains are good and food prices settle down. To get a sense of the inflation trajectory, the central bank will watch for the size of the fiscal deficit and to gauge how disciplined the new government proposes to be. It is true that real interest rates are high, but one appreciates Governor Shaktikanta Das’ concerns that the last mile of disinflation can be an arduous path. So, it would not be prudent to undo the gains achieved. Also, the RBI has asserted it would not “follow the Fed”, but would consider local factors, indicating that it would go ahead with any policy changes—ahead of the Fed—if the situation is favourable.
Even if the rate cut is delayed beyond October, easier liquidity conditions should prevail in the second half of the year, after India’s inclusion in the JPMorgan Bond Index later this month and increasing government expenditure. This should help interest rates at the short end of the curve ease and also boost bank deposits. The RBI is expected to leave a little more liquidity in the system than it has so far to ensure the growth momentum sustains. Liquidity in the system should be ample with loan growth expected to slow to 13-14% this year from 16% last year, after the clampdown on unsecured loans and the RBI’s constant reminder to banks that they should maintain a balance between the increase in assets and liabilities.
In fact, slowing credit growth would temper real GDP growth for FY25 as would the fading benefits from commodities-led terms of trade, limited fiscal impulses, and weaker exports resulting from slower global growth in the second half of the year. Given that the GDP for FY24 was boosted by the wholesale price index-led deflator and the gross value added (GVA) is a more relevant number, it would be helpful if the RBI provides a GVA number. The headline number masks the pitiable growth in private consumption last year of 4% on a modest base. The RBI’s claim that rural recovery is picking up seems premature; agriculture grew at an anaemic 1.4% in FY24 while real rural wages have now contracted for nearly 25 straight months. To be sure, there is elbow room but it is not “greater”.