Lower inflation, manufacturing pick-up split opinions on rate cuts

Ball is in RBI's court with low inflation and high growth conundrum

Deciding on the rate trajectory will not be easy when the Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) meets in October, especially with inflation settling lower than anticipated and growth showing signs of a pickup, according to experts.

While inflation ticked up to 3.7 percent in August compared with 3.6 percent in the previous month, the second quarter trajectory is likely lower than the RBI’s estimate of 4.4 percent.

“Softer food inflation should pave the way for the RBI to initiate rate cuts. In our base case, we expect two rate cuts this fiscal, with the first one in October unless risks from geopolitics and weather shocks push the rate cut decision,” said Dharmakirti Joshi, chief economist, Crisil.

But others contend that higher food inflation may prevent RBI from moving on rates soon.

Food inflation inched up to 5.7 percent in August compared with 5.4 percent in the previous month. But more than the slight uptick, economists are worried about the stickiness of prices in categories such as cereals and pulses.

“The positive effects of better Kharif sowing would be visible only post-harvest, i.e. October 2024 onwards. Till that time, pulses inflation is expected to remain in double-digits and cereals inflation would also be above 6 percent,” said Paras Jasrai, senior analyst, India Ratings and Research.

Pulses inflation has remained above double digits for 15 months in a row.

Growth comes into play

Some experts say manufacturing showing signs of revival and growth holding up may urge the bank to remain in a wait-and-watch mode for longer.

Manufacturing activity bounced back to 4.6 percent in July compared with 3.2 percent in the previous month.

Jasrai noted that with 12 of 23 sectors performing better, the sector may be showing some signs of broad-basing.

Despite elections in the first quarter, the manufacturing sector remained steady, growing 7 percent in the first quarter of FY25 compared with 5 percent in the previous year.

Jasrai is expecting no rate cuts this year.

But Aditi Nayar, chief economist, Icra, believes that the tepid GDP performance—growth was at 6.7 percent lower than RBI’s estimate of 7.1 percent—may urge the MPC to move on rates.

“A change in stance…can’t be entirely ruled out,” Nayar noted.

Expectations of a rate cut from the Fed rising after lower inflation print in the US and oil prices softening are expected to add more variables to the mix.