MPC Minutes: Make No Haste!

A delayed or no-cut scenario from the US Fed is a big risk for the EM rate cycle

Indranil Pan & Deepthi Mathew,

Economics Knowledge Banking.

YES Bank

Mumbai, April 22, 2024: MPC minutes focused on the impending uncertainties to inflation – food and non-food and clearly guided towards continued vigil on the dynamics for inflation. High sustaining growth alongside reducing inflation provides the RBI with the room to continue to hold rates for longer. Any decision on monetary policy pivot would crucially be held back till “the layers of uncertainty clouding the near-term clears”. A delayed or no-cut scenario from the US Fed is a big risk for the EM rate cycle. For now, we see the possibility for the first rate cut in India in October 2024 (earlier call was for August 2024). 

“To tread the last mile of disinflation with extreme care”: 

Dr Jayanth Varma called for a 25-bps rate cut and change in stance to ‘neutral’ highlighting that a real interest rate of 2% could risk the growth momentum in the economy. However, other MPC members cautioned against any pre-emptive policy adjustments given the uncertainties in the current scenario. Dr Ranjan was of the view that the MPC should remain patient till it gets some clarity on SW monsoon & its spatial distribution, rabi production & procurement and kharif sowing. This rules out the possibility for a rate cut in June 2024. Dr Patra highlighted the rising risk from food inflation in the summer months, given a relatively shallow and shortlived winter trough. He further added that “the headroom provided by the steady core disinflation and fuel price deflation does not assure a faster alignment of the headline with the target”. Governor Das also shared a similar view that the frequent incidences of supply side shocks - especially to food inflation due to adverse weather events and other factors - could disturb the inflation trajectory. The continuing geo-political tensions and their impact on commodity prices and supply chains is another area of concern. Dr Ranjan pointed out input prices are showing some signs of upticks that need close monitoring. 

Optimistic on growth evident: 

MPC members emphasized that growth is appearing more resilient, with Dr Patra also indicating that the output gap has closed. Expectations of a normal monsoon are also likely to boost rural demand. On the other hand, surveys have indicated a rising consumer confidence. Further, as Dr Das points out, capacity utilization is now ruling above the long period average, implying an impending boost to domestic private investment activity. Even with strong robust growth, core inflation remains less than 4% and is continuing to fall. However, based on our forecast, we expect core inflation to pick up in H2FY25. This needs to be watched carefully, implying a need for monetary policy to remain restrictive to align inflation to the 4% target level. 

Key messages: 

1. inflation uncertainties continue, b) hard work till now on controlling inflation cannot be surrendered, c) forward guidance not possible: The above lines summarize the key themes highlighted by majority of MPC members. Projections for monsoon are positive and the El Nino is expected to give way to La Nina. However, India saw a shallower winter season price correction in vegetables and as we head into the summer months, the ongoing heat waves conditions domestically create the first layer of uncertainty for the inflation trajectory. The next layer of uncertainty is from the commodity prices globally. Even as supply chains are on the mend, the geopolitics is concerning, especially with an escalation of the Iran-Israel crisis. Firmer-than-expected global growth is also likely to keep the commodity prices sticky. With growth conditions robust, a pass-through from the input side to output prices is possible. Given the above uncertainties regarding inflation and with the backdrop of sustaining high growth (leading to the closing of the output gap), there seems no justification for the RBI to attempt to reduce interest rates on a pre-emptive basis. Importantly, the projections and views with respect to the inflation trajectory can change if some of the assumptions do not materialize. Thus, the RBI would have to wait for incoming information, especially with respect to the monsoons and its impact on kharif sowing, to have a better grip on the food inflation projections going forward. Clarity also is warranted on the impact on domestic inflation from geopolitics. This also leads to the point that it would be risky to provide any forward guidance on rates. The US Fed was expected to bring down rates lower in June, but recent speeches from Fed members has successfully pushed away the date of the first rate cut. And we hold on to our belief that it could be risky for the RBI to move ahead of the Fed, as interest differential between India and US is low, and USD appreciation has led to depreciation pressures for EM currencies, including in the INR. Overall, there is growing confidence that a) the RBI will not be able to cut before October 2024 and b) rate cycle in FY24 will be restricted to only 50 bps.
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