RBI policy bullish on growth, cautious on new inflation risks

Reserve Bank of India (RBI) Governor Shaktikanta Das.

The final meeting of the Monetary Policy Committee (MPC) for FY2024 bore no surprises on action around the policy rates and the stance, with both being left unchanged. However, the voting pattern on the policy rate was not unanimous, unlike the previous policy, with one MPC member voting for a 25 bps rate cut. The voting pattern on policy rates is now aligned with that on the stance, at 5:1.

Growth Prospects

Interestingly, the MPC seemed quite optimistic around growth outcomes for FY2025. It anticipates GDP to grow by 7 percent in FY2025, on top of the National Statistical Office’s (NSO) first advance estimates of 7.3 percent for FY2024, extending the expectation of growth in excess of 7 percent for three years in a row. It expects growth to be supported by an improvement in household consumption, robust fixed investment, and the improved outlook for global trade and rising integration in global supply chains. The Committee has revised the quarterly GDP growth projections for Q1, Q2 and Q3 FY2025 upwards quite sharply, by 50 bps to 7.2 percent, 30 bps to 6.8 percent, and 60 bps to 7.0 percent, respectively, vis-à-vis the previous policy, while issuing fresh projection of 6.9 percent for Q4 FY2025.

The Committee’s growth projections are significantly higher than our own estimates; we expect GDP to grow by 6.2 percent in FY2025, after rising by 6.5 percent in FY2024. The decline in output of major kharif crops and weak prospects for rabi crop in the current fiscal, are expected to dampen rural sentiments and consumption in early-FY2025, until there is some visibility around the outcomes for the next kharif crop. Additionally, the recent tightening of norms for personal loans and credit cards by the Reserve Bank of India (RBI), is likely to impact credit growth for these segments, which could also weigh on discretionary consumption of urban households.

We concur with the MPC’s assessment around the pre-conditions for the kick-off of a private capex cycle being in place. However, we do not expect an improvement in external demand or exports to contribute significantly to GDP growth in FY2025. In the Interim Budget for 2024-25, the Government expanded its on-budget capex by 16.9 percent in FY2025; however, we are apprehensive the capex could be tepid in the run up to the parliamentary elections. Once the full budget is presented, presumably in July 2024, the monsoon would be upon us, which typically has a tempering effect on the pace of capex. Accordingly, we are circumspect about the pace of growth of economic activity in the first half of the next fiscal.

The Inflation Forecast

The Committee has cut its CPI inflation projection for Q4 FY2024 to 5 percent from 5.2 percent earlier, while keeping its FY2024 estimate unchanged at 5.4 percent. Thereafter, it expects the CPI inflation to average at 4.5 percent in FY2025, with the quarterly projections for Q1 through Q4 FY2025 at 5 percent, 4 percent, 4.6 percent and 4.7 percent, respectively. Notably, the projections for Q1 and Q3 FY2025 have been cut by 20 and 10 bps, respectively.

We expect the CPI inflation to come in at 5.3 percent in FY2024, with a sub-5 percent print for Q4. Thereafter, we estimate the CPI inflation at 4.6 percent in FY2025, broadly in line with that of the Committee. Our CPI inflation forecasts, like those of the MPC, are also based on the assumption of a normal monsoon, and the actual playout of the same would be critical in determining the trajectory of food inflation in the next fiscal.

Although the RBI Governor highlighted that risks to the inflation trajectory were evenly balanced, he stressed on the lingering uncertainties in the backdrop of recurring food shocks and the consequent de-anchoring of inflation expectations and generalisation of price pressures, and the impact of renewed geopolitical disruptions.

Shallow Rate Cut Cycle From August?

Overall, the MPC’s bullish expectations around the growth outlook and its forecast of CPI inflation to ease, albeit remaining above the 4 percent target, reinforces our view of a likely shallow rate cut cycle. We foresee cumulative rate cuts of 50-75 bps, commencing in the August 2024 meeting, and a stance change in the preceding review, after there is some visibility on the monsoon turnout.

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Interestingly, the RBI Governor highlighted that the policy stance of withdrawal of accommodation should be seen in context of the incomplete transmission of rate hikes as well as inflation ruling above the 4 percent target. This statement comes in the backdrop of the conflict in the stance with the pumping of liquidity into the banking system via VRRs since December 2023. While we expect liquidity conditions to remain tight in the near term, some easing is likely in early-FY2025, owing to the onset of the lean season as well as potential dollar purchases aided by expectations of modest CAD prints along with capital inflows owing to the bond index inclusion.

The 10-year G-sec yield has been volatile after the large easing seen post the Interim Budget. For it to decisively move below 7 percent, we believe the following three conditions need to be met: the inflows related to the bond index inclusion need to commence, the Fed’s rate cut needs to be on the table and at least the stance change from the MPC needs to be announced. All these conditions are likely to be met only after June 2024.

Aditi Nayar is Chief Economist, Head- Research & Outreach, ICRA. Views are personal, and do not represent the stand of this publication.