The RBI MPC left the repo rates unchanged at 6.5 percent at its meeting on June 08, as the Street had expected. The MPC continued with the ‘withdrawal of accommodation’ stance, as liquidity has turned into a significant surplus mode, further increased by the impact of deposits of Rs 2000 notes.
A change in policy stance at this juncture might not be in sync with the current liquidity conditions. Headline CPI is still higher than the medium-term target of 4 percent, even on a 12-month forecast horizon. A sustained moderation in inflation may prompt the shift from a “withdrawal of accommodation” to a “neutral” stance.
Although the market is divided about the future course of action of FOMC; we believe we are on a prolonged pause in India (unless there are some external shocks, EL Nino conditions surfacing, etc).
India’s retail inflation eased to 4.7 percent YoY in April 2023 (18-month low) on account of the high base effect supported by softening in overall food prices. Trends for May suggest inflation could ease further, which can be seen from the sharp downward revision of the Q1FY24 inflation forecast by the RBI. The impact of the favourable (high) base effect on inflation is likely to continue in the coming few months; gradually bringing the inflation reading down in the absence of any external or internal supply shocks.
The IMD has retained its long-range forecast for the southwest monsoon at 96 percent of the LPA, implying normal monsoons. But there is a high probability of El Nino developing during the latter part of the monsoon. Although El Nino episodes in the past have not always led to a substantial rise in food inflation, this cannot be ruled out.
Moreover, risk could arise from output cuts by OPEC+ and its impact on imported inflation due to a rise in global crude oil prices. Geo-political disruption and the consequent impact on global commodity prices are other risks for inflation.
Notably, input price pressures have receded sharply (WPI below zero), hinting at the possibility of core goods CPI moderating, and services inflation also remaining soft. Given the uncertainties around the prevalence of El-Nino conditions leading to sub-par monsoon in 2023; RBI remained cautious and revised the inflation projection down by only 10bps to 5.1 percent for FY24.
Normalisation of the base, slowing external demand, and uncertain financial conditions would take real GDP growth to 6.5 percent in FY24 (RBI projection). Weaker global growth, lagged impact of RBI’s rate hikes and the development of El-Nino conditions during the monsoon season are the critical risks to GDP growth in FY24.
Headline inflation across countries is on a downward trajectory, but is still high and above the targets. Longer than expected rate hikes would increase the interest rate differential, making things difficult for emerging markets' central banks like RBI to cut rates in the near term.
We think the central bank seems to have fewer concerns about growth rather than around the inflation outlook. This was clearly echoed in Governor’s statement; moreover, his statement reiterated the focus to achieve the inflation target of 4 percent. The resolve by the RBI to do “whatever is necessary” to bring inflation down on a sustained basis to the median target is likely to push forward rate cut expectations to perhaps in February 2024 but that would be data dependent. The policy statement was a non-event from the equity markets perspective.
(With inputs from agencies)