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Rate decision

Decision and economic assessment

RBIs’ monetary policy committee left the repo rate unchanged at 6.5%, with one dissent vote (backed 25bp cut). Stance was also unchanged at ‘withdrawal of accommodation’, with an external member casting a dissent vote, calling for a change in stance to neutral.

Outlook

The undercurrents that face the RBI MPC are similar to the US Fed. Strong domestic growth momentum has allowed the central bank to stay focused on steering inflation back towards the target. Supply-side shocks nonetheless are the key risk on the anvil for domestic inflation, while strong growth limits the need for additional support from monetary policy levers for the time being. As the language remains cautious, market pricing for policy easing will continue to be pushed back. The latest baseline assumptions in the Monetary Policy Report pegs crude prices at $85pb for this year, unchanged from last year, besides factoring in a slight weakening bias in the rupee (see table). 

Policy transmission

Governor Das highlighted that policy transmission was work in progress. Separately, the RBI had noted[1] that monetary policy transmission to bank lending and deposit rates has been stronger in this cycle compared to previous cycles, likely due to the growing share of loans being pegged to the external benchmark lending rate (EBLR). The share of EBLR linked loans (in total outstanding floating rate rupee loans) rose to 56% in Dec23, while MCLR linked loans continues to moderate to 39.4%. We reckon that to facilitate greater transmission from banks, the central bank will prefer to lower the quantum of excess liquidity in the system.

Inflation nuances

1) Food will continue to be dominant influence

CPI inflation averaged 5.4% yoy in the first eleven months of FY24 (Apr23 to Feb24), with the trend marked by a higher 1H at 5.5% and moderation in 2H on a pullback in food and core price pressures. The evolving trend is close to our forecast of 5.3% for the year, from 6.4% the year before. We discuss relevant catalysts for the year ahead, with our forecast of 4.5% yoy in line with the central bank’s economic assessment.

Globally, the UN Food price index is down 10% yoy at the start of 2024, with different pockets including wheat, palm oil and other oilseeds easing, while supply concerns keep rice, coffee, sugar elevated (see chart). Domestically, the Indian Meteorological Department (IMD) has warned of extreme heat conditions during April to June. Encouragingly, however, the latest assessment on the El Nino Southern Oscillation (ENSO) system, by the US government weather forecaster, suggests that beyond the neutral El Nino conditions that could prevail in 2Q24, La Nina might emerge thereafter, helping to lower temperatures. Kharif (summer) output was marginally better than normal area sown (see chart).

In the fuel space, local developments have been conducive. LPG refill prices were cut in 4Q23 alongside increase in the cylinder subsidy. In March 2024, LPG prices (1.3pp weightage in the CPI basket) were cut by another INR200/cylinder, following an INR 2/l reduction in retail diesel and petrol prices (~2.3pp cumulative). Any upward adjustment in fuel prices in reaction to higher Brent is unlikely in this election year, shielding the fuel component.

2) What’s keeping core inflation low and the outlook ahead.

Sharp disinflation in core (ex-food and fuel) and core-core (non-fuel, transport, food, precious metals) gauges have been one of the highlights of the price dynamics since last year.

Two questions arise from this trend. Firstly, what is driving core lower. Secondly, persistent decline in the core momentum despite resilient growth has been counter intuitive.

3) Business price expectations are anchored.

Representing price expectations/ selling pressures of businesses, responses to the Mar edition of the business inflation expectations (BIE) survey, conducted by IIM Ahmedabad, shows that despite a small uptick in the BIE to 4.46% in Feb24 from 4.37% reported in Jan24, the average inflation expectation of the firms for the past twelve months has been largely steady around 4.3%, signaling anchored inflationary expectations. One-year readings are above target but benign at 4.8%, from 4.96% in Dec23.

4) GDP deflators corrected sharply in FY24 diverging from CPI inflation.

The last part of the discussion on inflation is the debate around a sharp correction in recent GDP deflators. GDP growth in the 4Q23 (3QFY24) nominal GDP growth was firm at 10.1% yoy, which translated to real GDP at 8.4%, which by extension implied that the deflator was weak at 1.7% yoy (see chart). The latter contrasts with the 5.4% run-rate for CPI inflation in that quarter.

Trend ahead

Tying all these drivers together, we expect the headline inflation to average 4.5% yoy through the year from 5.3-5.4% in FY24, softening in 1H and picking up in 2H. This is built on the assumption of a favourable monsoon trend and limited supply-driven shocks from commodities. Add to this, domestic fuel prices are expected to stay contained in an election year. Any unexpected deterioration in weather conditions can potentially add 40-50bp to the full-year average inflation. Core inflation is expected to bottom out around mid-2024 before turning up. The lift will be driven by base effects and our expectation of a modest pickup in consumption trends on the back of easing inflationary expectations, higher labour participation rate, positive wealth effects and easier financial conditions.  To that extent, we expect the core inflation to ‘catch-up’ with the headline and average 3.5% yoy in FY25, lower than the headline at 4.5%.

[1] Financial Stability Report December 2023


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