On the path of disinflation

It was an easy bet that the MPC of RBI would keep the policy repo rate unchanged at 6.50 per cent – seventh pause in a row – in its first bi-monthly meeting for 2024-25 that concluded on April 5, 2024. Moreover, that the decision to maintain status quo would invite one dissent was also a foregone conclusion. Given this backdrop, the financial markets did not react to the policy announcement in any noticeable manner.

The tone of the statement accompanying the policy announcement is one that brings out RBI’s resoluteness to steadfastly buttress the current path of disinflation till inflation reaches the 4 per cent target on a durable basis. It has reaffirmed that the policy must continue to be actively disinflationary to ensure anchoring of inflation expectations and fuller transmission. More significantly, the MPC has categorically stated its belief that that durable price stability would set strong foundations for a period of high growth. This is fundamental to the conduct of the monetary policy under an inflation-targeting framework.

It was an easy bet that the MPC of RBI would keep the policy repo rate unchanged at 6.50 per cent – seventh pause in a row – in its first bi-monthly meeting for 2024-25 that concluded on April 5, 2024. Moreover, that the decision to maintain status quo would invite one dissent was also a foregone conclusion. Given this backdrop, the financial markets did not react to the policy announcement in any noticeable manner.

A year since the last hike

In the days following the last hike in the policy repo rate by 25 basis points in February, 2023, a section of the market expected the MPC to hike more, which did not happen, thanks to the steady decline in core CPI inflation throughout 2023-24 and moderation in headline CPI inflation in its second half. Expectations of policy easing in India gathered momentum from January this year, occasioned by similar expectations rising in several advanced economies, including the US. The reasons put forth by the lone dissenting member of the MPC who advocated a rate cut in its meeting in February this year are pretty straightforward: Real interest rate is close to 2 per cent now, which is high by historical standards and can lead to overcorrection and a fall in the growth rate.

The tone of the statement accompanying the policy announcement is one that brings out RBI’s resoluteness to steadfastly buttress the current path of disinflation till inflation reaches the 4 per cent target on a durable basis. It has reaffirmed that the policy must continue to be actively disinflationary to ensure anchoring of inflation expectations and fuller transmission.

The majority opinion and views in MPC seem to favour no change in the policy rate at this stage, on the one hand, and refrain from providing any guidance for the future in this regard, on the other.  The main planks of their approach to these issues are: (i) India’s potential growth rate is now higher as a result of various structural reforms, and advancements in physical and digital infrastructure which provide more ‘policy space’ to continue with the current policy rate as also the stance, (ii) the cumulative rate hike by 250 basis points during May, 2022 to February, 2023 is still working its way through the real economy,  and (iii) despite the fall in core and headline inflations in 2023-24, the risks of a spurt in food inflation, imparting volatility to the trajectory of CPI inflation, are not trivial at all: after a correction in January this year, food inflation rose to 7.8 per cent in February.       

The reasons put forth by the lone dissenting member of the MPC who advocated a rate cut in its meeting in February this year are pretty straightforward: Real interest rate is close to 2 per cent now, which is high by historical standards and can lead to overcorrection and a fall in the growth rate. 

Further, RBI wants to avoid the kind of gyrations in the US treasury yields that have been witnessed since the last hike in the policy rate there in the current tightening cycle by the Federal Reserve in July last year. The markets there expected an early reversal in the US monetary policy cycle on the back of faster-than-expected decline in inflation and some forward guidance on policy rate cuts provided by the authorities.  In the words of a member of the MPC, as revealed in the minutes of its last meeting in February, 2024 ‘Expectations of a change make agents and market participants behave in a way as if the change has already happened, which makes managing the present even tougher’. This explains why RBI avoids providing any guidance or hint on the specifics of any future monetary policy action. 

Growth and inflation prospects

RBI remains optimistic about the growth prospects of the Indian economy, with the real GDP growth for 2023-24 being pegged at 7.6 per cent, underpinned by strong investment and an improvement in private consumption.

As compared to the last bi-monthly meeting of MPC held in February 2024, the projections for both real GDP growth rate and headline CPI inflation for 2024-25 have now been kept unchanged at 7 per cent and 4.5 per cent respectively.  In MPC’s reckoning, food price uncertainties, the recent uptick in international crude oil prices, upward bias in cost-push pressures faced by firms and geopolitical tensions constitute major upside risks to the inflation outlook.

Headline CPI inflation, which was 5.5 per cent in the first-half of 2023-24 eased slightly to 5.3 per cent in the following five-month period: October 2023-February 2024. As mentioned earlier in these columns, core inflation has been on a steadily declining path, falling to a low of 3.4 per cent in February 2024, driven by both core goods and services components.

As compared to the last bi-monthly meeting of MPC held in February 2024, the projections for both real GDP growth rate and headline CPI inflation for 2024-25 have now been kept unchanged at 7 per cent and 4.5 per cent respectively.  
In MPC’s reckoning, food price uncertainties, the recent uptick in international crude oil prices, upward bias in cost-push pressures faced by firms and geopolitical tensions constitute major upside risks to the inflation outlook.

High inflation would always be an obvious major issue that the RBI is tasked to acknowledge and combat head on. Needless to say, the pachyderm’s slow and ponderous exit to the forest may not be long-lasting. It may return at the slightest hint of any lowering of the guard.

The finishing line for the descent of headline CPI inflation to the target of 4 per cent, though in sight, is never crossed till it is actually and durably crossed. The journey to traverse the proverbial last mile may turn out to be arduous and painstaking for its length. The use of the ‘elephant in the room’ expression in this connection was a bit misplaced. High inflation would always be an obvious major issue that the RBI is tasked to acknowledge and combat head on. Needless to say, the pachyderm’s slow and ponderous exit to the forest may not be long-lasting. It may return at the slightest hint of any lowering of the guard.