By Shanti Ekambaram, Deputy Managing Director, Kotak Mahindra Bank
As widely anticipated, the Reserve Bank of India (RBI) has kept the key policy repo rate unchanged at 6.50 percent with the stance remaining focused on ‘withdrawal of accommodation’ to ensure that the inflation progressively aligns to its target of 4 percent without derailing the robust economic growth.
While we may have to wait for a change in the policy stance and then an eventual change in policy rates, the certitude reflected in the commentary is ebullient. That also shows how the RBI, through some deft policy moves, has managed to fight off ‘the elephant – the stubborn inflation’ and slowly send it back to the forest. The target of GDP growth at over 7 percent and target inflation at 4.5 percent for FY25 amply prove that hitherto the growth-inflation dynamics have played out favourably.
The overall optimism comes from the performance of few major macro indicators; stable growth, moderating inflation, buoyant consumption, forecast of an early normal monsoon, and a stable balance of payment scenario - aspects that drive our economy forward. Interestingly, any and all potential disruptions could come from global sources, factors which are beyond our control.
Stable growth factors
The economic growth continues to be healthy, supported by buoyant urban consumption and expected uptick in rural consumption, robust manufacturing and services PMI, growing capex investment, and a considerable improvement in the global environment. As of now, the overall estimates peg the real GDP growth at 7.6 percent for FY24 and 7 percent for FY25. The broader economic indicators justify such conviction; the manufacturing PMI has shown sustained expansion, services sector showed a broad based buoyancy, and the rural demand is showing some signs of revival. Capacity utilisation of core sectors have gone up, inducing the investment cycle to gain further traction. The Indian growth juggernaut seems firmly on its track.
Easing inflation and prospects of a normal monsoon
Domestically, the repetitive spikes in food prices during the last few quarters continue to be a big factor in RBI’s calculations. But, for the moment, the early forecast of an above-average rainfall during the primary monsoon season - July to September – this year, following the transition from El Niño to La Niña conditions, should brighten the prospects of a stable food inflation and a resurgent rural consumption.
In the last two months, headline inflation has hovered around 5 percent, from 5.7 percent in December 2023. The core inflation is on a steady decline over the past nine months with fuel component going into a deflation for six consecutive months.
Thus, the realisation of a normal monsoon and a good harvest can tilt the argument in favour of an early rate cut.
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FMCG companies are reporting a growth in rural consumption, helped by a good rabi crop harvest and improved prospects of kharif crops thanks to the forecast of a normal south-west monsoon. In fact, the strengthening of rural demand, better employment conditions, lowering inflationary pressures, and growing prospects in manufacturing and services sector can further lift private consumption, which has been one of the pillars of India’s rapid economic stability.
The continuous surge in private capex cycle, which is now becoming more broad based, sustained government spending, and rising capacity utilisation are also boosting the overall business optimism.
Stable external scenario
The highest ever forex reserves at $645 billion and the record remittances in the last quarter at $29 billion show the durability of our external balance of payments situation. The foreign portfolio investment (FPI) flows have also seen a significant turnaround in FY24. As of now, the overall current account deficit (CAD) for FY25 is manageable, after narrowing down during the first three quarters of FY24. The Indian rupee had the distinction of being the most stable among major currencies, riding on the country’s macroeconomic fundamentals.
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Risks to the above are any spike in global energy prices, escalations in geo-political tensions, and other supply and trade side disruptions. This could bring volatility into our economy – both for growth and inflation.
Global trends
The global economic and trade outlook has remained resilient and stable so far. But aligning the overall inflation to respective targets and containing the last mile of disinflation is becoming a big challenge, as acknowledged by major central banks. While the expectation of a rate cut across advanced economies is very high and immediate, tight labour markets, volatile equity markets and erratic current and bond yields make such decisions much harder. For RBI, the high public debt to GDP ratio in most advanced and emerging economies is a concern for its potential spill-over effects in the form of extreme volatility in capital flows and financial markets.
Further escalations in geopolitical tensions and growing threats to major trade routes can aggravate the overall vulnerability.
Also Read: RBI has played conservative on both growth and inflation; may follow Fed for rate cuts
Specific to the inflation, vegetables and certain categories of pulses can alter the picture of comfort besides the looming adverse climate shocks. The proverbial ‘elephant in the room’ – the stubborn inflation that peaked to 7.8 per cent in April 2022 - seems to be retreating into its natural habitat. For it to disappear and post a threat no longer, the monetary policy must remain actively disinflationary and ensure anchoring of inflation expectations without compromising on sturdy growth.
For a few quarters more, the RBI has to keep a vigilant eye on that elephantine factor to keep it submissive.
(The author is Deputy Managing Director at Kotak Mahindra Bank Limited)
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