RBI hopes a favourable monsoon will help it contain food inflation, cut rates

The Reserve Bank of India (RBI) chose to keep the repo rate unchanged for the eighth time in a row at 6.5 percent last week to maintain economic stability amid a favourable growth outlook. The inaction on the rate front reaffirms the central bank's commitment to bring down inflation to the 4 percent target level. This would ensure price stability, and set a strong foundation for long periods of high economic growth.

Food inflation

RBI Governor Shaktikanta Das reiterated that despite core inflation hovering below 5 percent, the central bank continued to be challenged with sustained hike in food prices, making it harder to bring inflation closer to its medium-term target of 4 percent.

Food inflation remains a cause for concern even though core inflation has already embarked on a deflationary trajectory (corrected by 200 basis points over the last 11 months), he said.

Last year, the monsoon was quite erratic, leading to a sharp drop in water levels across major reservoirs. Additionally, there was unseasonal rainfall in the later part of the year in some areas. This impacted the yield for some rabi crops, which may have fuelled the inflationary trend.

Vegetable prices kept simmering after a below-normal winter correction, adding to the inflationary woes. A normal monsoon this year would be important for food prices to cool off. In fact, given the expectation of a normal monsoon this year, the CPI inflation for 2024-25 is being projected at 4.5 percent — much closer to the RBI's target range.

Resilient economic growth

India's real GDP grew at a robust 8.2 percent in FY24. Even in FY25, economic activity remained resilient, with eight core industries posting healthy growth in April 2024. Manufacturing PMI as well as GST collections in May also look good. The services sector too remained buoyant, and private consumption is showed signs of recovery with steady rise in discretionary spending in urban areas.

Investment is gaining traction on the back of  healthy corporate and bank balance sheets, and merchandise and service exports too have put up good growth in April 2024, thanks to improved global demand. An above-normal south-west monsoon, as forecast  by the Indian Meteorological Department (IMD) should boost kharif production and lift rural consumption.

Considering all of these factors, the RBI has improved its projection of GDP growth to 7.2 percent, from 7 percent earlier.

Volatile global factors

Global economic growth continued to sustain its momentum in 2024, supported by a rebound in international trade. However, inflation continued to remain a bit sticky and the final leg of the disinflation journey is expected to be tough. Therefore, central banks around the world remain steadfast in their fight against inflation, and market expectations on the timing and pace of interest rate cuts continued to change with incoming data. Also, commodity prices remained volatile due to climate change, and ongoing geopolitical tensions are only adding to the concerns.

All of this has led to the US Federal Reserve still reviewing its rate cut plans for the year, leading to higher rates remaining a possibility for a longer period.

Hence, financial markets, once buoyed by expectations of an early end to the monetary tightening cycle, have turned volatile, showing significant two-way movements in response to the recent policy reviews and macro fundamentals. It appears that a global consensus is emerging on achieving a sustained reduction in inflation before considering rate cuts.

For the moment, the RBI's strategy appears to be to retain its focus on withdrawal of accommodation to manage inflation  and ensure fuller policy transmission, while supporting growth. Economic growth holding firm is giving the central bank enough manoeuvring space in its fight to contain inflation. As acknowledged by the RBI governor, the final phase of the disinflation journey is expected to be particularly challenging — hence the call  for "poise, patience, and perseverance".

As a corollary, market expectations on the time timing of interest rate cuts have also shifted, with fewer cuts being anticipated this fiscal compared to the beginning of the year, contingent upon sustained signs of cooling inflation.

(The author is president and h ead of commercial banking at Kotak Mahindra Bank)