MPC meeting: Inflation elephant hogs attention; interest rate change unlikely

The monetary policy committee (MPC) will keep the 6.5% repo rate—the rate at which the central bank lends to banks—unchanged for the eighth consecutive time, a Mint poll of 10 economists found. The MPC may also keep the monetary policy stance unchanged at withdrawal of accommodation. However, the economists expect the policy stance to be revised to neutral in the second half of the year, along with a rate cut.

Elephant in the room

Governor Shaktikanta Das recently compared inflation to an elephant in the room, that is now returning to the jungle. “The elephant moves at a slow pace. The last mile of disinflation is always challenging and sticky," Das had said. A day after the general election results are announced, the MPC goes into its bi-monthly meeting from 5 to 7 June.

Also read: India’s retail inflation marginally eases to 4.83% in April

"GDP print suggests growth is moving faster than expected by the RBI, which means the central bank should see little urgency to cut rates while the MPC waits for comfort on headline inflation. In our view, the MPC will likely vote 5-1 to keep the policy mix unchanged at its meeting next week. We also do not expect the bank to reduce rates before Q4 FY25 given its own inflation trajectory and persistent upside surprises in growth," said Rahul Bajoria, head of emerging markets Asia (ex-China) economics research at Barclays.

High inflation

Retail inflation has cooled since December, with consumer price index (CPI) falling from 5.69% to 4.83% in April this year. While inflation is within the RBI's mandate of 2-6%, it remains above the target of 4%. Core inflation, which is a better measure of underlying price pressures in the economy, is at a multi-year low of 3.2%, suggesting weakness in demand.

Also read: GDP blitzkrieg in FY24 keeps India ahead of its major-economy peers

Despite the fall in CPI, food inflation in April surged to 8.7% from 8.52% in March. In its annual report, the RBI had also highlighted that the outlook for overall inflation and food inflation remain uncertain due to increasing incidence of climate shocks.

While RBI expects CPI to fall to 4.5% in FY25, the final fight to bring inflation down to the desired 4% is turning out to be a protracted one.

“The recent inflation data and the outlook for prices of food and commodities had suggested a status quo on the rates and stance in the upcoming June 2024 monetary policy review," said Aditi Nayar, chief economist, Icra. "This has been further cemented by the higher-than-forecast expansion in the Indian economy in Q4 FY2024, which led to the full-year GDP growth printing above 8%. As a result, the likelihood of a stance change in August 2024 followed by a rate cut in October 2024 has eased, unless an abundantly well-distributed monsoon quells food prices in a sustainable fashion," Nayar said.

Also read: RBI keeps eyes on inflation, finger on pause button

Strong economy

Meanwhile, the economy remains in good shape, with GDP growth for FY24 revised upward to 8.2% from 7.6% as per the government's second advance estimates. This is also higher than RBI's projection of 7% growth for FY24. Economists expect RBI to retain inflation outlook for FY25 at the current level, and perhaps raise GDP outlook by 10-20 basis points.

The central bank, however, may start cutting rates only towards the second half of this financial year, once food inflation starts easing after a normal monsoon.

"We maintain that the RBI will not precede the Fed in any policy reversal in CY24 and policy management will have to stay vigilant amid fluidity of global narratives. We stand by our view of early 2024, that both Fed and RBI won’t cut rates this year and CY2025 will also be a shallow cycle," said Madhavi Arora, lead economist, Emkay Global Financial Services.

Also Read: FM asks corporates to 'join in a big way' to push up India's growth trajectory

On the liquidity front, RBI is likely to continue with its measures including variable rate repo (VRR) auctions to manage demand. Liquidity has remained in deficit in May at ₹1.42 trillion, compared with a surplus of ₹20,240 crore in April. The pressure on liquidity has been due to limited government spending during the period of general election.

Some clarity is also expected on how the central bank will manage the foreign exchange surplus on account of India’s inclusion in JPMorgan Chase & Co.’s emerging market debt index.