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Informist, Thursday, Aug 8, 2024

 

By Shubham Rana and Pratiksha

 

MUMBAI – India's monetary policy has been at a standstill for well over a year now, with the Reserve Bank of India's rate setting panel last changing the repo rate in February 2023. The MPC has also kept the policy stance unchanged at 'withdrawal of accommodation' since June 2022.

 

While the tide is turning globally--with central banks in Europe and the UK having already lowered interest rates and the US Federal Reserve widely expected to lower rates next month--the Indian central bank is unlikely to follow suit anytime soon.

 

Comments by RBI Governor Shaktikanta Das today suggested that the Indian central bank is nowhere close to a pivot with inflation still above the 4% target and growth staying robust.

 

Persistent food price shocks have slowed down the disinflation process, Das said. India's headline CPI inflation rose to a four-month high of 5.08% in June, mainly on account of a rise in food prices.

 

The high food price momentum is likely to have continued in July, even as a favourable base effect may push headline inflation downwards, Das said. According to an Informist poll, CPI inflation is seen falling to 3.7% in July, the first sub-4% print in nearly five years.

 

With food prices, especially vegetables, ruling high, the RBI raised its CPI inflation forecast for Jul-Sep by 60 basis points to 4.4%, even as it retained the full year inflation projection of 4.5%.

 

This suggests that the RBI expects the rise in food prices to eat away much of the advantages of the high base effect this quarter.

 

"This (4.4% Jul-Sep inflation) forecast, we think, assumes no major vegetable price disinflation over the next few months," HSBC said in a note. "If the 10% month-on-month fall in vegetable prices in the first week of August were to continue, there could be downside risks to this forecast."

 

Das went out of his way to explain why the MPC needs to continue to focus on food inflation even as core inflation, which excludes food and fuel items, is at a record low.

 

Higher food prices adversely affect household inflation expectations, which have a significant impact on future trajectory of inflation, Das said. "Persistently high food inflation and unanchored inflation expectations--if they materialise--could lead to spillovers to core inflation through pick-up in wages on cost-of-living considerations," he said.

 

The governor said that ensuring price stability would strengthen the foundations for a sustained period of high growth. The central bank kept the GDP growth forecast for 2024-25 unchanged at 7.2%, while it lowered the growth forecast for Apr-Jun by 20 bps to 7.1%, citing lower than anticipated corporate profitability, and general government expenditure.

 

It is the relative comfort on growth at present which allows the RBI to focus unequivocally on inflation. RBI Deputy Governor Michael Patra said that the neutral interest rate, which rose to 1.4-1.9% during Jan-Mar from 1.1-1.3% during Oct-Dec 2021, shows that the current level of the policy repo rate at 6.50% is "probably exactly right".

 

FINANCIAL STABILITY

Das had some warnings and directions in store for the banking sector.

 

In the wake of a rise in alternative investment avenues like equities by households, Das put the onus on banks to mobilise deposits using innovative ways, to avoid potential liquidity issues.

 

Das said credit growing faster than deposits could potentially expose the banking system to structural liquidity issues. According to the RBI data, as of Jul 12, bank deposits grew 11.3% on year compared with 14.0% growth in loans. Das said that although the financial system is gaining strength and remains resilient, the emphasis cannot shift away from identifying potential systemic risks, highlighting that certain segments of personal loans continue to see high growth.

 

The governor also asked banks to proactively monitor the end-use of home equity loan, known as top-up housing loans in India. He highlighted that certain banks and non-bank finance companies have been offering top-up loans on other collateralised loans like gold loans.

 

"These comments reaffirm the RBI's caution towards certain pockets in the banking space and could lead to some growth moderation for banks going ahead," Madhavi Arora, chief economist at Emkay Global Financial Services, said in a report.

 

Striking a balanced tone, Das said that the central bank will ensure that money market interest rates evolve in an orderly manner. "India has built strong buffers that impart resilience to the domestic economy from such global spillovers. The Reserve Bank remains committed to ensure orderly evolution of financial markets in its regulatory domain," he said.

 

The governor also made sure to indirectly address and calm investors' nerves in the backdrop of the recent volatility-inducing global events. Das said, quoting Mahatma Gandhi, that "the slightest error of judgement, a hasty action or a hasty word may put back the hands of the clock of progress. Policies have, therefore, to be cautiously evolved."

 

 

Das also said that the growing conversation around a potential recession in the US is premature, suggesting that he is not aligned to market participants' expectations of an aggressive rate cut cycle in the world's largest economy.

 

"Overall, if you look at the economy in the US, I think it's doing quite well," the governor said. "So far as unemployment is concerned, it is just one-month data. Based on one-month data, you cannot assume or rush to a conclusion about the possibility of a slowdown or recession in the largest economy of the world. You have to wait and see the incoming data."

 

Most market participants were expecting a delayed rate cut from the MPC even before today’s policy outcome, with most expecting the first rate cut in December and some in February. While today's policy outcome has not altered any of the expectations, it has most certainly cemented them.

 

This policy marks the end of the term of the three of the external members of the Monetary Policy Committee. There will be a new set of external members in the next policy in October. Will a new set of external members lead to a shift in the broad thinking of the rate-setting panel?

 

New brains or not, Das' message to markets is simple--as long as growth remains strong, aligning inflation to the 4% target durably is the only destination for India's monetary policy.  End

 

Edited by Akul Nishant Akhoury

 

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