Interview | RBI likely to hold rates at least till December: IDFC First Bank economist Gaura Sengupta

Gaura Sengupta - IDFC first bank

The Reserve Bank of India (RBI)-led Monetary Policy Committee (MPC) is likely to remain in pause mode for the remainder of the year as inflation risks may persist, mainly because of lower-than-expected rainfall during the monsoon season, said Gaura Sengupta, economist at, IDFC First Bank.

Meanwhile, on the growth front, the recovery has proven resilient despite faster transmission of past rate hikes (under the external benchmark regime) and a weak external growth environment, she said. Q4FY23 GDP growth had surprised on the higher side at 6.1 percent, supported by capex and consumption, Sengupta said.

Edited excerpts from the interview follow:

Q: What is the impact of the Rs 2000 note withdrawal on the liquidity of notes?

The impact of the Rs 2000 rupee note withdrawal on liquidity is mainly via the reduction in currency in circulation as individuals deposit part of the notes with banks. The Rs 2000 note withdrawal process has been quicker than expected with Rs 1.8 trillion of the notes returned out of a total outstanding amount of Rs 3.6 trillion.

Interestingly, 85 percent is being deposited while the rest is being exchanged for other notes. At the current pace, the entire process should be completed by mid-June 2023. The higher proportion of notes being deposited indicates that decline in currency in circulation will be higher. The maximum impact of liquidity is likely to be in the month of June, with liquidity expected to reduce from July onwards as currency leakage picks up. The liquidity boost from Rs the 2000 note withdrawal is expected to be transient.

Q: How do you see inflation playing out?

The May CPI (Consumer price index) print at 4.25 percent was mainly in line with expectations. A part of the moderation in year-on-year inflation is due to favourable base effects, which have the maximum impact in the first quarter of FY24. Details reveal that the moderation in May CPI was led by food, followed by core and fuel inflation. The slowdown in core inflation in particular is positive as on a seasonally adjusted basis the month-on-month increase has remained moderate at 0.3 percent, averaging from March 2023 to May 2023 v/s near-term highs of 0.5 percent to 0.6 percent.

Looking ahead, headline inflation in June is also tracking at 4.3 percent, after building in daily food prices till the first half of the month, which showed a pick-up in prices of vegetables, fruits and pulses. For the full year, FY24 CPI inflation is expected to average at 5.0 percent, broadly in line with the RBI’s estimate. The key risk to inflation remains the monsoon, with a high chance of El Nino conditions developing. Given the delayed arrival of the monsoon, the performance in June is likely to remain below normal. However, from a crop output perspective, July is important as the majority of the sowing is completed by then.

Q: India’s retail inflation eased to a more-than-two-year low of 4.25 percent in May on an annual basis as against 4.70 percent in April. How do you see its impact on banks?

From a monetary policy perspective, we expect the RBI to remain in a prolonged pause (at least till December), with CPI inflation not expected to reduce to the 4 percent target on a durable basis in FY24. Growth recovery has proved resilient, with IIP growth surprising on the upside at 4.2 percent YoY in April. Other high-frequency indicators show that strong growth conditions continued in April / May 2023, supporting our expectation of FY24 GDP growth of 6.2 percent. The relatively resilient growth recovery provides monetary policy space to focus on reducing inflation to target levels, on a durable basis.

Q: How do you see the current account deficit shaping up?

In FY24 we expect the current account deficit to reduce to 1.8 percent of GDP, supported by the reduction in the trade deficit, with crude oil prices remaining moderate and an elevated services surplus. The services surplus in particular has surprised, averaging at $12.2 billion per month reflecting strong growth in software services and professional services.

At the same time, the trade deficit has been gradually narrowing despite the decline in merchandise exports, as imports have contracted even more, reflecting the reduction in commodity prices and moderation in domestic demand. Indeed over December 2022 to April 2023, the sum of services and merchandise balance is averaging at $3.8 billion per month versus $11.8 billion per month over January 2022 to November 2022. We expect these trends to persist in FY24 with the reduction in the trade deficit and a robust services surplus. However, going forward we do expect some moderation in the services surplus as growth conditions in DMs (developed markets), which are the primary export destination, weaken.

Q What is your outlook on interest rates?

For now, we expect the RBI to remain on pause till at least December given our expectation that CPI inflation won’t moderate to the 4 percent target on a durable basis.

The key risk to inflation remains the monsoon. Meanwhile, on the growth front, the recovery has proven resilient despite faster transmission of past rate hikes (under the external benchmark regime) and a weak external growth environment. Q4FY23 GDP growth had surprised on the higher side at 6.1 percent, supported by capex and consumption.

Hence, as long as real rates remain below or even at 2 percent, the RBI could remain on pause as growth conditions have held up. In case the inflation trajectory changes and shows durable moderation to 4 percent and real rates are higher than 2 percent, then chances of a rate cut could arise. In our base case, we expect the RBI to remain on pause till December, based on FY24 CPI inflation averaging at 5 percent.

Q: How do you see the impact of El Nino, and the rising price of rice on inflation?

The impact of El Nino will depend on how it affects the temporal and spatial distribution of the monsoon. In terms of temporal distribution, the monsoon performance in July is more important than June, as the majority of sowing is completed by then. In terms of spatial distribution, if the performance is weaker in well-irrigated areas, then the impact on crop output will be smaller.