Opinion: When will RBI cut rates? The question everyone is asking as inflation cools, albeit slowly

The key trend is to watch out how costly the platter is getting

The country’s policymakers at the finance ministry and the Reserve Bank of India (RBI) will keep a close eye on two sets of data that came out on February 12.

The index of industrial production (IIP), which is perhaps the most appropriate proxy to measure activity across India’s factories, grew 3.8 percent in December, higher than the previous month’s 2.8 percent expansion, although a tad slower than the 5.1 percent expansion in the same month of 2022.

Consumer price index (CPI)-based inflation, which serves as a realistic metric to gauge trends in shop-end price movements, grew 5.1 percent in January 2024, down from 5.69 percent in December, and more than a one-a-half-percentage point lower than 6.52 percent recorded in 2023.

More than the factory output, the government and the RBI will firmly keep one eye on the price line. Retail inflation, the key determinant for RBI’s interest-rate related decisions, is still above the central bank’s comfort zone of 4 percent.

A persistently high price line will not be a good augury for it tells the story that getting by is not getting any easier. Inflation has very high political sensitivities too, and the government would like the price genie firmly bottled up, particularly in election year when it can potentially rally into a poll issue.

The key trend is to watch out how costly the platter is getting. Consumer food price inflation (CPFI), grew 8.3 percent in January 2024, more than a one percentage point drop from the previous month’s 9.53 percent. If the trend persists, which the government hopes, it should get closer to the previous January 6 percent food inflation levels.

Importantly, inflation in non-food non-fuel items, which economists refer to as “core inflation” as it serves as a more realistic measure to assess price trends without the volatile food and energy prices, was steady at 3.6 percent in January 2024 compared to 3.8 percent in December 2023.

Policymakers could see this sequential easing of the inflation curve as a good sign, raising hopes of interest rate cuts sometime later in the new financial year. The RBI has remained unwavering in its focus on cooling inflation and has not lowered the repo rate — the benchmark policy rate at which banks borrow from the central bank over six policy meeting cycles.

Cooling inflation should encourage the RBI’s monetary policy committee (MPC) to eventually lower rates, which can reduce capital raising costs for corporations and reduce loan rates for individuals.

The factory output data as shown in the IIP numbers mirror some pick up in demand, although it may be a tad too early to fit a defining trend.

Consumer durables output grew 4.8 percent in December 2023 from contraction of 11.2 percent in the same month of the previous year. While this expansion may be largely driven by a low base effect, a statistical phenomenon that magnifies small changes, it still shows that factories are producing more refrigerators, washing machines and similar products now than a year ago.

Factories raise output levels when there are signs of demand for their goods. That said, it may still take a few more months for factories to add more capacity lines to fulfil additional consumer demand.

Capital goods output grew 3.2 percent in December 2023, slower than the previous December’s 7.8 percent growth, implying that there could still be unused capacities lying in some factories.

Companies would be hoping that cooling inflation will prompt interest rate cuts, which will help them raise money at lower costs when they plan to enhance their production capacities in anticipation of rising consumer demand in a few months from now.