The Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) is like a marathon runner, pacing itself through the challenging terrain of inflation and economic growth. Recently, the committee has had to navigate rising prices influenced by global supply chain disruptions and volatile domestic food costs. Each meeting is a careful balancing act, where members weigh their options like runners adjusting their stride to maintain speed without losing stamina and momentum. With controlled inflation as their finish line, these discussions are crucial for ensuring that India’s economic journey stays on track, avoiding pitfalls while sprinting towards a stable and prosperous future.
Last month marked the eighth anniversary of India adopting inflation targeting as part of its monetary policy framework. Drawing from international experiences, this approach has yielded several positive outcomes in India, including more stable and less volatile headline inflation, well-anchored inflation expectations, improved communication and transparency, better transmission of monetary policy, increased independence for the central bank, enhanced coordination with fiscal authorities, and more effective management of exchange rates and reserves in response to external shocks.
Under the inflation targeting regime, the RBI is tasked with maintaining inflation within the 2-6% range, with a specific aim to keep it close to 4% on a durable basis. The committee has held the repo rate steady at 6.5% for the ninth consecutive time, as food inflation continues to pose a significant threat to retail inflation.
Though core inflation, which excludes food prices and fuel, has moderated to a more manageable level, headline inflation might rally upwards due to volatility in food prices. Sporadic rainfalls and the gradually weakening rupee among global economic fluctuations and geopolitical uncertainties might push food prices further upwards.
Despite a slight increase in India’s retail inflation this year from 3.6% in July to 3.65% in August, the MPC has successfully kept the Consumer Price Index (CPI) well below its 4% target for the second consecutive month in five years. The decline in inflation is primarily due to positive base effects. The RBI has consistently raised concerns about elevated food inflation, which could impede the ongoing easing of inflationary pressures. Food costs, which account for approximately half of the Indian consumer basket, rose by 5.66% year-on-year compared to 5.42% in July.
In light of the rate cuts being implemented by many Western countries, including the recent 50 bps reduction by the Federal Reserve, it remains unlikely that the RBI will follow suit in their upcoming MPC meeting, scheduled for the 7th of this month. After nearly 20 months of high policy rates that have tapered inflation, RBI Governor Shaktikanta Das is looking for clearer signs that price increases are sustainably settling around the central bank’s target before thinking about a rate cut.
Considering that the committee welcomed three new members just before the meeting, analysts are of the opinion that the newly constituted MPC will need more time to familiarise themselves with the issues before deciding on a rate cut, with the former expecting rate cuts to start from December this year. Two of the three external MPC members whose terms ended were more dovish than their RBI counterparts in recent rate meetings, voting for rate cuts.
In August, the country experienced a negative year-on-year growth in exports, primarily due to weakened demand from Western markets coupled with high shipping costs due to scarcity of containers and the Red Sea crisis, which has increased the turnaround time. This situation is compounded by the possibility that any hasty relaxation of monetary policy could weaken the Indian rupee. A depreciated rupee though increasing the competitiveness of Indian goods abroad also makes imports dearer, potentially leading to an increase in the current account deficit, owing to the high value and essential nature of imports (crude oil). Weaker rupee would also make servicing foreign debt amounting to USD 682.3 billion onerous. Trade deficit of USD 29.65 billion underscores the fragility of India’s external trade environment, which is further complicated by ongoing geopolitical uncertainties. Since decline in exports is due to demand side considerations, any premature easing of monetary policy could make the situation of balance of payments even more critical.
The rising tensions in the Middle East, triggered by Iran’s missile attack on Israel, could disrupt oil supplies. It’s no surprise that oil prices surged following news of Iran’s military action. There are growing concerns that this regional conflict might escalate into a broader war, potentially impacting global interest rate trends.
In light of these challenges, Governor Das’ emphasis on waiting for solid evidence of sustained price stability before considering any monetary policy adjustments underscores a commitment to a measured and strategic approach. Balancing the need to support domestic growth while ensuring that inflation remains in check is a tightrope walk that the central bank must navigate carefully in these unpredictable times. The interplay of domestic economic factors with the shifting dynamics of global trade will be pivotal in determining the future trajectory of both India’s economy and its monetary policy. Though a rate cut is imperative and imminent, less can be said about the exact timeline with economic experts divergent on their predictions. With many expecting rate cuts to begin from December this year, once elections in the US settle to take into account the policy stance of the new government, while also making sure that the inflationary tendencies of the economy have indeed subsided and that the relief is not just temporary in nature.