By Indranil Pan, Chief Economist at YES Bank
The monetary policy of the RBI rightly weighed the evolving landscape of domestic growth and inflation. Importantly for the RBI and for the larger cause of policy making, the risks on the horizon are now appearing to be either stabilizing, or getting more manageable and there is more certainty to economic outcomes out of the policy settings. The action consequently was on predicted lines – no change in the policy repo rate and an unchanged stance of the monetary policy – namely to remain focused on the removal of accommodation.
In continuation to the policy statement of April, the commentary this time also exhibited a good comfort on the growth outlook for the economy. Growth projections for FY24 have been left untouched at 6.5 percent. This is higher than market consensus, even after economists have upped their growth numbers for FY24 after having factoring in a much higher-than-expected outturn for Q4FY23.
RBI’s projected GDP is also higher than some multilateral agencies: World Bank now projects FY24 GDP growth at 6.3 percent while IMF has put out a 5.9 percent expectation. The good part of India’s growth is that it is mostly domestic led and even as one expects exports to underperform in FY24 due to a global slowdown, the fact that imports have also come down sharply will reduce the drag on GDP growth from net trade.
With the anticipation of stability of the growth trajectory, the focus of the RBI is rightly rivetted towards anchoring inflation expectations, and durably bringing inflation towards the anchor rate of 4 percent. This is where the tone of the policy becomes a bit on the hawkish side, which is also trying to set up the right expectations of the market from monetary policy. This is important as the market was probably building in some expectations of a change in stance to “neutral” from “removal of accommodation”, aptly evident in the domestic 10-year G-sec yields having tumbled to 7 percent, while the 3-month T-bill trades at 6.74 percent, implying a tenor premium of just 25 bps.
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Going ahead, the RBI will have a critical eye on the evolution of the inflation trajectory. The Q1, Q2, Q3, and Q4 FY24 inflation expectations of the RBI are 4.6 percent, 5.2 percent, 5.4 percent and 5.2 percent respectively. This is clearly indicative of the fact that even with an assumption of normal monsoons, inflation is likely to move back to a higher trajectory.
Add to this is the Australian Meteorological Bureau’s ENSO outlook being now changed to an “alert” status (from and earlier “watch” status). There is now roughly a 70 percent chance of El Nino forming and playing truant with the southwest monsoons in India. Remember that the IMD has projected a normal monsoon with 96 percent of Long Period Average, but this is on the lower end of the scale. Any significant alteration of the timeliness and distribution of the southwest monsoons could have implications on food inflation and needs to be watched.
The important point that the RBI makes is that, even as inflation is expected to come down, the focus of the monetary policy again shifts to achieving the 4 percent central target. The RBI’s priority as the economy was coming out of the crisis period was to bring inflation within the tolerance zone and after this was achieved, for some time the RBI was content to operate within the tolerance band.
However, with a gradual clearing out of the dark clouds and with a relatively better certainty on the economic outcomes, the RBI would once again focus on bringing the inflation rate to the 4 percent handle on a durable basis. This is not getting achieved at least in FY24, as indicated by RBI’s own projections as we have laid out earlier.
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What does all this analysis mean? “The last leg of the journey is the toughest” says the RBI Governor, implying that achieving the 4 percent target will surely not be easy. Immediate risks are the southwest monsoons, but longer-term risks remain in the form of geopolitical worries (the implication is for commodity and oil prices), deglobalization (implications for lower global trade volumes), global ageing population (structural inflation risks for the globe as current consumption increases with a rise in dependency ratio).
Thus, the Governor’s statement at the April meeting “pause and not a pivot” continues to hold water, implying that any thoughts that the markets might have started to have in terms of an early rate cut are now thrown out of the window. Looking at the inflation trajectory, we now think that the RBI will possibly be on an extended pause all through FY24.
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