As inflation rises, hopes of rate cuts fade

The current spike in inflation comes from vegetable prices, the core inflation is more anticipated and accounted for.

Are we experiencing the same dilemma that the US Federal Reserve constantly undergoes? Despite a consistent quantitative tightening of the Fed’s balance sheet and hikes in the policy rate of interest, the US inflation invariably finds some or other reasons to remain buoyant. The more it hiked rates, the more the inflation stayed firm.

Even though our inflationary outlook and its targeted range remain more or less the same, for the Reserve Bank of India (RBI) governor, Shaktikanta Das, robust economic indicators, consistent inflows, a sound banking system and a strong credit offtake give much more room than Jerome Powell. While the current spike in inflation, possibly as high as 6.2 percent in July, comes from vegetable prices, the core inflation is more anticipated and accounted for. With an improvement in the monsoon, helping the sowing of Kharif crops, India may avoid potentially prolonged food inflation. But both Powell and Das will face a daunting task if the global economic uncertainty worsens or factors including El Nino reduced the effectiveness of the monetary policy levers.

Walking The Tightrope

With the Monetary Policy Committee (MPC) alluding to the need for fine-tuning the monetary policy to ensure limited impact on the growth due to the inflation targeting, thereby avoiding demand destruction and damage to the economy, it always remains a challenge to walk the tightrope. As such, the decision of August 10 to hold the policy rates with a hawkish commentary was largely expected.

Yet, the upward revision in the inflation forecast, up to Q1 FY25, and the decision to tighten liquidity through the incremental cash reserve ratio (I-CRR) amply reflected Mint Street’s concerns. As the governor put it, “bringing headline inflation within the tolerance band is not enough; we need to remain firmly focused on aligning inflation to the target of 4.0 percent.” The persisting and anticipated inflationary pressures have forced the central bank to hike the consumer price index (CPI) inflation forecast for FY24 to 5.4 percent from 5.1 percent, to 6.2 percent from 5.2 percent for Q2FY24 and to 5.7 percent from 5.4 percent for Q3FY24. The RBI’s inflation outlook for a period up to Q1 FY25 has been revised upwards, thus indicating a rate cut is far away on the horizon.

Clearly, the central bank is trying to remove elements of concern from the system to sustain growth with financial stability. The move to cut the temporary liquidity overhang from the return of Rs 2,000 banknotes through an I-CRR of 10 percent, on the increase in banks' net demand and time liabilities (NDTL) between May 19, 2023, and July 28, 2023, will help the price stability. These funds are expected to return to the system ahead of the festival season, boosting domestic consumption.

“In data we trust” is the normal dictum among policymakers, worldwide. In the background of monetary policy levers becoming increasingly exhausted in the fight against inflation globally, the RBI’s move to wait for more monetary transmission data from the earlier hikes will give it a lot more clarity and direction to act. The inflationary elements — be it crude prices or extreme weather — are well entrenched and perhaps a new tolerance band may even be considered. Meanwhile, one hopes that the US Fed does not add to RBI’s quandary by hiking rates a few more times in the interim.

Virat Diwanji, Group President and Head – Consumer Bank, Kotak Mahindra Bank. Views are personal, and do not represent the stand of this publication.