Run-up to RBI monetary policy review: Expect another hawkish pause
The Monetary Policy Committee (MPC) is expected to maintain the status quo on policy rates for the fourth time in a row at its October 4-6 review meeting. The additional information available since the last meeting in August suggests that growth and inflation figures for the second quarter (Q2) of the financial year 2023-24 (FY24) will exceed the committee’s projections.
However, consumer price index (CPI)-based inflation is expected to moderate in the second half (H2) of FY24. Furthermore, we are concerned that gross domestic product (GDP) growth will be 100 basis points (bps) lower than the MPC forecast for the second half of FY24, and we believe that a policy tightening on this moment is not justified.
The increase in headline CPI inflation is expected to be transitory. The print had cooled to 6.8 percent in August 2023, compared to a fifteen-month high of 7.4 percent in July. It is expected to fall further to 5.5 percent in September, once the full impact of the tomato price crash is included in the CPI calculation. This implies an average CPI inflation of 6.6 percent for Q2FY24, which beats the MPC estimate by an unpalatable 40 basis points. However, the overshoot is not expected to feed into the MPC’s CPI inflation projections for the third and fourth quarters of FY24, which marginally exceed our own estimates.
Moreover, core inflation has declined over the past seven months, reaching a 22-month low of 5.1 percent in August 2023, providing some comfort to the committee. However, the risks posed by the uneven and sub-par monsoon and the recent spike in crude oil prices would trigger aggressive reactions in the MPC commentary.
GDP growth for the first quarter of 2024, at 7.8 percent, was only marginally behind the MPC’s estimate of 8 percent for that quarter. Encouragingly, high-frequency indicators suggest that momentum in economic activity has remained strong during the second quarter of 2024, against the backdrop of robust construction activity and healthy domestic demand. ICRA expects India’s GDP growth to reach 7.0 percent in the second quarter of 2024, higher than the MPC’s estimate of 6.5 percent for that quarter.
Thereafter, the pace of GDP growth in the second half of FY24 is expected to decline compared to the first half. In addition to the disappearance of the favorable base, the impact of subnormal monsoons on agricultural production and the rural economy, the delayed effects of monetary tightening, the narrowing of commodity price differentials from year-ago levels, the continued weakness of external demand and a potential The slowdown in government capital expenditure in the run-up to the 2024 general election is creating significant headwinds.
The MPC’s CPI projection of 5.2 percent for Q1 25 implies a forward-looking real policy rate of 1.3 percent; We believe that a higher real interest rate is not justified at this time. We therefore expect the MPC to leave the policy rate unchanged later this week, while sounding cautious on inflation amid the continued focus on achieving the 4 percent inflation target.
System liquidity tightened significantly in the second half of September 2023, largely due to early tax outflows. This situation is unlikely to continue, especially as the substantial amount seized under the I-CRR is set to return to the banking system later this week. We expect the MPC to maintain the policy position given the concerns about excessive liquidity raised by Committee members in the August 2023 minutes.
The writer is Chief Economist, Head of Research and Outreach, ICRA