RBI may pause in August policy; signal rate cut still distant as inflation climbs, say economists

Reserve Bank of India

The Reserve Bank of India (RBI) is likely to maintain a pause in its August monetary policy, and may signal that a pivot to rate cuts remains distant after the Consumer Price Index (CPI)-led inflation rose to 4.81 percent in June, economists said.

India's headline retail inflation rate snapped its four-month falling streak and rose to 4.81 percent in June from 4.31 percent in May, pushed up by a rise in vegetable prices, and fading away of the favourable base effect, data released by the Ministry of Statistics and Programme Implementation on July 12 showed.

"The RBI will keep rates tight at 6.5 percent for the time being, and rate-cut expectations will be pushed forward if the upward pressure on inflation increases in the coming months," said Sakshi Gupta, Economist, HDFC Bank.

Further, Aditi Nayar, Chief Economist, Head - Research & Outreach at ICRA, said the spike in vegetable prices is set to push the CPI inflation to an uncomfortable 5.3-5.5 percent in July 2023.

"We expect the vegetable price shock to result in the Q2 FY24 CPI inflation exceeding the MPC's last forecast of 5.2 percent," Nayar said.

In the last two monetary policies, the central bank did not hike the repo rate due to better economic data and inflation coming down to the RBI’s medium-term target.

Currently, the repo rate stands at 6.50 percent.

Also read: Retail inflation snaps falling streak, rises to 4.81% in June

June inflation

Despite CPI inflation in June rising to 4.81 percent, the average for the first quarter of 2023-24 remained at 4.6 percent, as projected by the central bank in the monetary policy.

In its June monetary policy, the RBI projected inflation at 5.1 per cent for 2023-24, with Q1 at 4.6 per cent, Q2 at 5.2 per cent, Q3 at 5.4 per cent and Q4 at 5.2 per cent.

CPI inflation extended its stay within the RBI's tolerance band of 2-6 percent to four months. It has now been above the central bank's medium-term target of 4 percent for 45 months in a row.

The uptick in June inflation is driven by vegetable prices.

Nayar added that amidst the ongoing excess rainfall in North India, the surge in the prices of perishables, particularly vegetables, is likely to harden food inflation further in the immediate term.

"This trend in vegetable prices continued in July too. Core inflation was broadly unchanged at 5.1 percent but will likely moderate over the next few months. Overall, we see upside risks to CPI inflation over the next few months as monsoon-related risks on food prices play out," said Suvodeep Rakshit, Senior Economist, Kotak Institutional Equities.

However, Vivek Kumar, Economist at QuantEco Research, said food price pressure will not be durable, and more importantly, a strong catch-up in rainfall activity in the last three weeks should boost sowing activity and trigger a mean reversal in volatile food prices (especially vegetables) before the end of Q2 FY24.

In addition, administrative interventions could be deployed once again to curb price pressures in the case of cereals and pulses (to some extent), Kumar added.

Also read: IIP growth rises to 5.2% in May

RBI rate pause

The central bank has been holding rate hikes since April due to better economic data and domestic conditions.

Prior to this, the RBI increased the repo rate by 250 basis points (bps) to tame higher inflation. One basis point is one-hundredth of a percentage point.

For most of the time since the start of the rate hike cycle in India, inflation has remained above the RBI’s upper tolerance band of 6 percent.

The pause in two monetary policies has seen government bond yields ease by more than 30 bps. Due to this, the borrowing costs on other debt instruments also eased.

Currently, the yield on the 10-year benchmark 7.26 percent 2033 bond stands at 7.1160 percent.

According to Gaura Sen Gupta, Economist at IDFC, RBI will remain on a prolonged pause until at least December 2023.

"The RBI is likely to look through the transient surge in food prices, which is better dealt with by supply-side measures," Gupta added.