Growth Gains But Inflation Pains: RBI's view on Indian Economy

While the MPC collectively recognised the Indian economy's resilience amidst global challenges, there was a sense of caution regarding the persistent inflationary pressures affecting private consumption. Acknowledging the economy's reliance on both government and private investments, as well as urban and rural spending, the committee remained wary of inflation's ongoing impact on consumer behavior. Highlighting the diverging risks, the MPC noted inflation risks leaning upwards while growth risks tended downwards. The majority of MPC members, barring Prof Jayanth Varma, agreed that maintaining the current policy rate was the appropriate course of action. This decision aimed at nurturing sustained growth while still looking to anchor inflationary pressures. In its most recent MPC meeting held on April 8, the Reserve Bank of India (RBI) opted to retain the main policy rate at 6.5% and continue with the gradual withdrawal of liquidity. 

Governor Shaktikanta Das highlighted the robust growth exhibited by the Indian economy, maintaining an average of 8% annually over the past three years, positioning it as the fastest-growing major economy globally. This growth has been supported by a resurgence in manufacturing and sustained expansion in the services sector. Despite the positive trajectory, Das underscored the need for cautious monetary policy actions to address the persistent risks of inflation, particularly driven by volatile food prices and geopolitical tensions affecting commodity prices. Deputy Governor Dr. Michael Patra echoed concerns about elevated food inflation and cautioned against premature relaxation of the restrictive stance. According to him, a brief and minor decrease in winter prices is giving way to growing price momentum as summer approaches, with forecasts indicating rising temperatures until May 2024. Some global food prices are stabilizing due to increasing input costs and pressures on supply chains. Despite core components experiencing steady disinflation and fuel prices seeing deflation, there's uncertainty about headline inflation aligning swiftly with the target. Consequently, headline inflation is anticipated to remain close to the upper limit of the acceptable range until favorable base effects take effect in Q2 of FY25. Thus, the conditions for any relaxation in the restrictive stance have not yet materialised. 

Further, the MPC was of the view that domestic demand is on the rise, and the output gap has closed. Although the investment outlook is looking up, there's an expectation for a stronger rebound in private consumption and corporate sales growth. Supply responses are also improving, contingent upon factors like a normal monsoon, a revival in private investment to enhance manufacturing sales and mitigate capacity constraints, and sustained growth in services. The external balance sheet remains robust, with a modest current account deficit, strong capital flows, and increasing foreign exchange reserves. This is expected to protect domestic economic activity from global spillovers resulting from changes in monetary policy stances of major central banks that are either underway or impending. Furthermore, the minutes revealed that another MPC member, Dr. Rajiv Ranjan was of the view that globally, market expectations are set to early and swift rate cuts by leading central banks .This is particularly for advanced economies. However, incoming data in these economies reveals a divergence from this expectation, contributing to uncertainty regarding the timing of policy easing cycles in major economies. In contract, in India, market expectations currently appear to be aligned with MPC assessments, and therefore, fostering consistency in policy expectations that support anchoring of long-term inflation expectations is critical. Meanwhile, other members reiterated similar views. 

In contrast, Prof Jayath Varma reiterated his stance from the previous meeting, advocating for a rate cut to alleviate the burden of high interest rates on the economy and stimulate growth. He noted that despite the recent uptick in crude oil prices, the inflation outlook remains favorable. He emphasized that maintaining a real interest rate within the range of 1-1.5% would effectively steer inflation towards the target of 4%. Therefore, the current real policy rate of 2% (based on projected inflation for FY25) appears excessively high, according to him. He argued that this elevated real rate unnecessarily burdens the economy. Additionally, he added that the projection of a more than half a percent slowdown in economic growth for FY25 underscores the growth costs associated with high interest rates. As a result, Varma advocated for a 25 basis points interest rate cut and a shift in stance to neutral.

In summary, while the MPC remains optimistic about India's growth prospects, concerns about inflationary pressures persist. While projections for FY25 suggest the possibility of rate cuts, it seems from the minutes that the RBI is inclined towards maintaining the current rates to ensure a consistent progress towards the inflation target. The emphasis on cautious and nuanced approaches highlights the uncertainties surrounding both growth and inflation dynamics. In our assessment, despite the availability of room for a rate reduction, the RBI is expected to keep rates unchanged at least until the conclusion of the national elections in May 2024. A minor rate cut of 25 basis points is anticipated in Q2 (July-September) of FY25, followed by another in Q3-FY25, bringing the rate down to 6% by the end of 2024.