By Indranil Pan
India is in a sweet spot. Despite the tightening of policy rates, the optimism has persisted on the growth front. Purchasing managers’ index (PMI) manufacturing and services have shown firmness and are confidently sitting in a >50 zone that marks expansion for the economy. Growth hit 8.2% in FY24 and is projected to remain firm in FY25 at 7.1%. Importantly, southwest monsoon is expected to be normal this season, and El Niño will turn into La Niña in the second half of the year. There are already signs of improvement in rural demand that could be bolstered with good monsoons. Further, headline retail inflation had been trending lower and is now within the target band. External sector risks are minimal with the current account deficit/gross domestic product ratio likely at 0.5-0.7% for FY25, despite prices of crude oil and other commodities remaining sticky. Recently, good news also came from the S&P as it improved the rating outlook to “positive” from “stable”. With growth being on a stable setting, the focus of the Reserve Bank of India (RBI) is to attain the 4% inflation target on a durable basis.
The direction of inflation is on the benign side. After the vegetable price-led shock to the headline consumer price index (CPI) print at 7.4% in July 2023, the headline reading has now come down to 4.8% according to the last reading. After the February policy, the two readings that the RBI would be armed with are for March and April. Even as the year-on-year readings are stable at around 4.8%, the sequential momentum (month-on-month reading) has been higher in April at 0.5% compared to 0% in March. Importantly, the momentum for food inflation has also been higher at 0.7% in April compared to 0.2% in March. Further, the momentum for the core inflation went up to 0.6% in April compared to 0.1% in March. According to Yes Bank’s model calculations, headline CPI inflation is likely to average around 4.3-4.5% in FY25, like the expectation of the RBI.
Over the last few policies, the Monetary Policy Committee members have consistently argued about the uncertainties that border inflation expectations and the punch statement has been “to tread the last mile of disinflation with extreme care”. One cannot forget the 2023 spike in tomato prices and vegetable prices have already seen an increase. India has also seen a shallower winter season price correction in vegetables and as we head into the summer months, the heatwave conditions domestically create the first layer of uncertainty for the inflation trajectory. Moreover, water reservoir levels are below their decadal average and groundwater tables are depleting in many parts of the country. Any noise around the southwest monsoon (predicted to be normal from an overall precipitation perspective), especially with respect to spatial and temporal distributions, could be damaging for the food inflation trajectory.
The next layer of uncertainty is from the commodity prices globally. Even as supply chains are on the mend, the geopolitics is concerning, especially with an escalation of the Iran-Israel crisis. Firmer-than-expected global growth is also likely to keep commodity prices sticky. Importantly, higher commodity prices will boost wholesale price index inflation, and this can be passed on to end users, given that growth remains on a solid footing. The RBI reports that for Q1FY25, services sector and infrastructure firms expect higher input costs. While services sector firms expect selling prices to rise, infrastructure firms do not expect the same. In PMI surveys, manufacturing firms indicated a rise in input prices but did not expect output prices to rise. Thus, at the headline retail level, inflation is likely to be more from the services side than goods.
The RBI has also been indicating that India’s monetary policy reaction crucially depends on domestic conditions and the US Fed may not have much of an impact. However, I think the RBI is unlikely to precede the Fed in this rate-cutting cycle as the interest rate differential between the two economies is at historic lows. The data prints have indicated a relatively stronger US economy compared to the other major economies. Till a few days back, markets were pricing in for the first rate cut by the Fed in September. Now, at the time of writing, the CME FedWatch Tool indicates a 52% chance of no rate cut in September. The first rate cut by the Fed has shifted to November 7, 2024, with a 45.3% probability. Chances of no rate cut by the US Fed in November also remain high at 40%. This scenario can, however, change rapidly if incoming data shows a rapid decline in US inflation, but as of now no model is predicting such an event.
So, “patience” is the word. Central bankers around the world are exhibiting this and so would the RBI. The upcoming monetary policy in June is unlikely to see any change to the rates or the stance. Given various uncertainties to the inflation trajectory, the RBI has desisted from providing any forward guidance on monetary policy and this strategy is expected to continue. The inflection points for inflation and rate cycles have always been difficult to call. In the current cycle, it has been made worse by the changing geopolitical landscape leading to global geo-economic fragmentation and significant climate changes. Inflation is probably more structural in nature now than cyclical. Central banks around the world would also not be willing to agree on any flexibility to the inflation targeting mechanism as it damages its credibility.
The timing of the first cut by the RBI is a tricky call. With the Fed likely remaining on hold till November, the RBI can be expected to start a cut in December. Whatever the start date, the extent of cuts in this cycle could be shallow. For now, I anticipate that rate cuts in India would be to the extent of 100-125 bps, spread over FY25 and FY26.
The author is Chief economist, YES Bank
Views are personal