Inflation, growth trend on track for first rate cut by RBI in early 2024

The RBI's Monetary Policy Committee last cut the repo rate in May 2020.

The Reserve Bank of India has hit pause on its tightening cycle in 2023-24, but could deliver its first interest rate cut in almost three years in early 2024, economists said.

The central bank's two objectives – inflation and growth – are seemingly on the right track. Data released on June 12 showed Consumer Price Index inflation fell to a 25-month low of 4.25 percent in May, while industrial production jumped by 4.2 percent in April.

Economists see conditions evolving such that the RBI's Monetary Policy Committee (MPC) may lower the repo rate in the last quarter of 2023-24.

"As growth slowdown seeps in and inflation moderates, we expect it to cut rates by the end of this fiscal," DK Joshi, CRISIL's chief economist, said on June 12.

To be sure, growth has surprised on the upside and made the government rather bullish about domestic activity levels, while prices are seen rising more rapidly in the coming months as the favourable base effect – that has helped drag down headline inflation by 227 basis points in four months – fades by October. However, this may only allow the MPC to continue to maintain the status quo until the end of 2023.

Underlying forces

The latest inflation and industrial production data has been described as a 'goldilocks environment' - one with high growth and low inflation. However, the underlying numbers – especially on growth – seem to be making the case for easier financial conditions in the coming months.

According to Rahul Bajoria, managing director and head of Emerging Market Asia (ex-China) Economics at Barclays, the rise in industrial growth in April was "mostly due to a large base effect".

Further, while "soft data" such as the Purchasing Managers' Index suggested faster growth in output in May, non-survey-based "hard indicators" such as core sector performance and fuel and power consumption "had already indicated likely sequential contraction in industrial production in April".

Economists also pointed out that while industrial growth was better than expected in April, the continued contraction in the output of consumer durables was disappointing. And there is also the small matter of faith, or lack thereof, in the Index of Industrial Production.

"It is important to note that the industrial production data has ceased to be a credible indicator for the quarterly industrial sector real gross value added, which is dependent more on corporate sector performance," said Kaushik Das, Deutsche Bank's chief economist for India and South Asia. This, he said, could pose downside risks "given that there could be risks to earnings downgrades, with prospects of significantly lower nominal GDP growth in 2023-24."

Economic activity should also soften in the coming months as the RBI's 250 basis points worth of repo rate hikes since May 2022 take hold. In terms of inflation, economists see the RBI making further cuts to its forecast for 2023-24 after it announced a 10-basis-point reduction to 5.1 percent on June 8.

"Despite upside risks on inflation (monsoons), there is further scope for the RBI to trim its inflation forecast in 2023-24, which it will likely change ex-post," noted Nomura economists Sonal Varma and Aurodeep Nandi, who see CPI inflation averaging 4.7 percent this financial year.

Peak rate exceeded?

When asked on June 8 if the current repo rate of 6.5 percent is appropriate to sustain growth in the long run, RBI deputy governor Michael Patra said the level is appropriate "at this point of time".

Not everyone agrees with that assessment.

As per the State Bank of India's Artificial Neural Network model of machine learning, the highest possible repo rate under four different scenarios is 6.23 percent – almost 25 basis points higher than where it actually stands.

It is no surprise then that Soumya Kanti Ghosh, SBI's group chief economic adviser, expects the RBI to cut the repo rate in January-March 2024.

"The magnitude could be larger than 25 basis points," Ghosh added.