Growth momentum continues, but private consumption and capex weak

Momentum may not sustain into next year; policymakers should stay vigilant and build buffers

Since the October Monetary Policy Committee (MPC) meeting, gross domestic product (GDP) growth in Q2 of 2023-34 (FY24) has come as a surprise, rising to 7.6 per cent year-on-year (Y-o-Y).
 

With strong momentum continuing so far into Q3, this suggests that FY24 GDP growth will likely rise closer to 6.7 per cent Y-o-Y (Reserve Bank of India or RBI estimates it to be 6.5 per cent).
 

However, growth intervals in Q2 were less encouraging, with demand primarily driven by the government, both on consumption and investment.
 

However, private consumption and private capex remain weak. We believe the current strong growth momentum may not sustain into next year. With a likely slowdown in global growth, India’s real GDP growth could slow to 5.6 per cent Y-o-Y in FY25.

Developments on the inflation front have been mixed, with both good (core) and bad news (food). The drop in headline inflation in October is set to reverse in November-December due to higher vegetable prices and a continued rise in cereals, pulses and sugar prices.
 

The latter are stickier in nature, and could remain under pressure, with India Meteorological Department (IMD) now projecting that El Niño conditions could last until mid-2024.
 

Encouragingly, underlying inflation has been contained. Core inflation has moderated to 4.3 per cent Y-o-Y in October, despite the upside growth surprise. With inflation expectations and wage pressures easing, and lagged monetary policy effects still ahead, we expect core consumer price index (CPI) inflation in the 4-4.5 per cent range over the next 12 months.

Combined with higher food price pressures in the near months, headline inflation is tracking largely in line with the RBI’s FY24 and FY25 estimates of 5.4 per cent and 4.5 per cent, respectively.
 

More than growth-inflation, liquidity dynamics have become important. Since the October MPC, banking system liquidity has largely remained in a deficit due to RBI’s forex (FX) intervention, higher currency in circulation outflows and a build-up of government cash balance. The weighted average call rate has hovered closer to the marginal standing facility (MSF) rate, which amounts to a stealth tightening by 25 basis points. This has precluded the need for more open market operation (OMO) sales and has enabled policy transmission, but it goes against the objective of keeping call rates closer to the repo rate.
 

The global backdrop has become less hostile, with markets now pricing in Fed policy easing before mid-2024, lower US yields and also a retracement in oil prices. This gives some breathing room for emerging market economies. Policymakers should use the current calm to build resilience, by scooping up more FX reserves and ensuring corporates are adequately hedged on their dollar liabilities.
 

Finally, the RBI’s decision to tighten risk weights on bank lending to non-banking financial companies (NBFCs) and unsecured loans is a good pre-emptive step. This will slow down the pace of consumer credit growth, but will also improve policy transmission and build medium-term resilience.
 

Overall, barring upside risks from food prices, monetary policy is in a good place, with robust growth and low core inflation. Even with no change in the policy rate, tight liquidity and higher risk weights are doing the job for policymakers. At the current juncture, policymakers should stay vigilant and build buffers, but there is no need to rock the macro boat.

The writer is chief economist (India and Asia ex-Japan) at Nomura