Banking Central | Pause on rates may stay as Inflation cools off, but war is far from over

RBI Governor Shaktikanta Das

The biggest development in the banking space last week was the lower inflation numbers for April that came out on Friday. To be sure, the April consumer price inflation came largely in line with expectations at 4.7 percent. This has been a piece of good news for the rate-setting panel that decided in favour of a pause to rate hikes last month.

As SBI economists wrote, the pause is vindicated as inflation dropped to an 18-month low. The cooling off in retail prices, though attributable to the base effect, will provide some comfort to the MPC to continue with the pause.

In this backdrop, there are a few aspects worth discussing here.

One, the good news is that the core inflation, or the non-food, non-energy part of the inflation, has been easing since the last two months. It fell to 5.06 percent in April from 5.74 percent in March. If one recalls, the MPC deliberations in the last meeting, a persistently high core inflation was a major concern for policymakers. Most economists believe that decline in the overall inflation numbers, particularly in lower core inflation, will provide room for the rate-setting panel to continue with the pause in the next policy meet scheduled on June 6-8. If low inflation sustains, one cannot rule out a rate cut later this year.

Two, the not-so-good news is that the upside risk to high inflation continues even at this stage.  A big factor to watch out for will be how the monsoon will pan out this year. While private agency Skymet has predicted below-normal rainfall, IMD has forecast a normal monsoon. Monsoon is critical in India as much of the country's agriculture activities depends on seasonal rains. Also the risks arising from El Niño continue to haunt with no clarity yet on the likely impact on India. The short point is that risk stays on for policymakers if the monsoon fails. The other risk is trajectory of the US Fed rate hikes, which will have ripple effects on interest rates in emerging markets such as India.

Three, despite the probability of a pause in June, there is nothing to suggest that MPC members are convinced about victory over inflation. In fact, going by the last policy meeting deliberations, majority of the MPC is of the view that inflation remains a threat and it is too early to lower the guard.

Among the external members, Jayanth Varma and Ashima Goyal highlighted the dangers of high inflation. While Varma said it would be premature to declare an end to this tightening cycle, Goyal asserted that because of erratic weather and continuing global uncertainties, and until it is clear that inflation is well on the path to sustain within the mandated 4-6 percent range, it is necessary to emphasise that this may not be the end of the rate hikes.

Governor Shaktikanta Das too said that the central bank’s fight against inflation is far from over and the efforts will continue to bring inflation closer to the medium-term target of 4 percent. As Moneycontrol highlighted in this story, despite the huge 174-basis-point fall in inflation over the last two months, it stays above the RBI’s medium-term target, 43 months on.

In this backdrop, while the April numbers offer a breather, probably guaranteeing a pause in June, the upside risks to MPC’s inflation fight continue to linger and the panel may have to take a U-turn if these risks materialise. The MPC is likely to remain on pause mode, for now.

Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.