With growth robust, RBI will hold its stance till disinflation is satisfactory

The wide spread financial market volatility in the last fortnight has brought the spotlight back on managing inflation without hurting growth.

The Reserve Bank of India (RBI) retained the key policy rates in the August 2024 review with the stance remaining unchanged as the global geo-political tensions and economic outlook continue to be volatile. Domestic growth remains resilient despite the food inflation pushing the headline inflation trajectory upwards in June even as the central bank’s efforts to anchor the inflation expectations at 4 percent level on a durable basis seem to have entered the crucial phase.

Even though major central banks have succeeded to an extent in their efforts to contain the inflation, the wide spread financial market
volatility in the last fortnight has brought the spotlight back on managing inflation without hurting growth. And this is what exactly the RBI is trying to achieve in the Indian context. Fortunately, the prudent monetary initiatives and the government’s fiscal support through infrastructure spends have kept the domestic growth momentum resilient. This has been aided by stable urban consumption, manufacturing growth, buoyant services sector and support from the rural areas where the demand is picking up. The robust growth momentum gives the RBI the leeway to focus on price stability, adequate market liquidity and market reforms.

The RBI Governor explicitly pointed out that food inflation contributed to more than 75 percent of the headline inflation in May and June, and remains a crucial factor to monitor. He also pointed out the potential risks of the higher food inflation spilling over into core inflation. The inflation trajectory has already been impacted by the soaring food inflation in June this year which, as per the overall inflationary expectations, can become stickier. Monsoons have been normal thus far and kharif sowing has been good. The impact of La Nina is yet to play out fully. In terms of systemic liquidity, the central bank has maintained sufficient liquidity to support the ongoing economic expansion besides reiterating its commitment to sustain adequate liquidity.

The Governor did touch upon the currency and the stability seen in the last one year. The recent global volatility has also had some impact on the Indian rupee. Given India’s comfortable forex reserves position, the RBI will use buffers to ensure currency stability. The stability and the healthy capitalisation level of the financial system was also mentioned.

The RBI, however, cautioned on potential challenges from attractive alternative investments to the accretion of stable retail deposits. The central bank has once again emphasised on prudent risk management, a strong monitoring of the credit and end use of funds, the need for a strong business continuity plan in the wake of the recent tech outage, monitoring of lending practices such as home equity loans and gold top-ups and better underwriting practices aimed at weeding out issues that could potentially impact the financial sector.

The message to banks is clear that they must innovate product-wise to garner larger share of the public savings which at the moment seems to be getting channelized into other investment avenues. The banks are facing immense pressure to manage and maintain competitive lending rates that may eventually get passed on to the customers. It is also hindering the banks from sustaining a reasonable credit-deposit ratio with a potential to slowdown system credit growth.

Overall, the RBI has highlighted a divergent policy stance from other central banks, fully committing to support a resilient economic growth with price stability. With an expected GDP growth of over 7 per cent for this fiscal and well into the early next as well, the central bank is going to tread cautiously in changing monetary policy stance and the rate trajectory till there is sufficient evidence of a durable inflation of 4 percent.