Sustained sub-5% inflation forecasts to give rate cut opportunity, says MPC's Ashima Goyal

A repo rate of 6.5 percent and a one-year-ahead inflation forecast of 5.2 percent results in a real policy rate of 1.3 percent. The central bank currently expects Consumer Price Index (CPI) inflation to average 4.6 percent in April-June, before rising to 5.2 percent in July-September, 5.4 percent in October-December, and 5.2 percent in the final quarter of 2023-24.

CPI inflation is seen falling to 4.5 percent in 2024-25. However, the central bank has so far not provided detailed quarterly inflation forecasts for the next financial year.

"Confidence that inflation is sustainably approaching 4 percent is required. For this core inflation also has to reduce. A sequence of forecasts below 5 percent would build that confidence," Goyal explained.

No complacency

One key takeaway from the MPC's June 8 decision was the emphasis on aligning inflation with the medium-term target of 4 percent. This focus has led to some economists pushing back their rate cut predictions from late 2023 to early 2024. Asked if the emphasis on reaching close to the 4 percent inflation target was deliberate, Goyal said yes.

"There is a mis-perception that the MPC is happy with (inflation at) 5 percent. Protecting welfare following the succession of supply shocks in the past few years required inflation to be higher. But now that growth is reasonably resilient, the 4 percent target can be emphasised," she said.

Market expectations of a lower repo rate in the coming months is also seemingly affecting the policy stance of the MPC, which remains focused on 'withdrawal of accommodation'. In her statement in the minutes of the June 6-8 meeting, Goyal said she favoured continuing with the stance as it was not possible to give a signal about future action. According to the Emeritus Professor at the Mumbai-based Indira Gandhi Institute of Development Research, there is some apprehension about how a change in the stance might be interpreted as "markets are already pricing in cuts in repo rates and need to be reminded that a rise is also possible depending on the data coming in".

Upside and downside risks

The Indian economy's performance as per latest data has been stellar, with GDP growth rising far more than expected to 6.1 percent in January-March, forcing the statistics ministry to raise its full-year growth estimate by 20 basis points to 7.2 percent. Although the government is bullish about the economy's prospects, Goyal advised caution, saying growth — while resilient — is "still below our potential".

"More employment is required. So sustaining high growth is important," she added.

On the inflation front, Goyal expects any adverse impact of the monsoon to be temporary.

"But since we have had a number of supply shocks it is better to wait for these effects to play out over the next few months," she said.

Within the CPI basket, Goyal sees the possibility of some cooling effect from lower fuel prices.

"Since the OMCs (oil marketing companies) have recovered earlier losses they should be cutting prices," she said.

Pump prices of petrol and diesel have not changed for almost a full year now even though the price of India's crude oil basket so far in June is 35 percent lower than the same month last year, per data from the Petroleum Planning & Analysis Cell of the government.

Some respite could also come from lower milk inflation, which edged up to 8.91 percent in May — the 10th month in a row it has gone above 6 percent, which is the upper bound of the RBI's inflation tolerance band  — amid supply issues and rising input costs. Goyal sees milk inflation reducing by Diwali as demand-supply imbalances dissipate. Beyond the next few months, though, the government must focus on improving infrastructure and incentives for the animal husbandry sector as the share of milk in household budgets will only grow with prosperity.