Rain check for RBI: Food inflation, El Niño risks make rate cuts unlikely

Keeping in mind the factors on crop prospects, it stands to reason that rate cuts are out, and an unchanged position can be expected.

Monetary policy targets headline inflation, and this remains a challenge. While the weight of food products has declined in the new CPI basket, it is still at a significant 35 per cent. The fact that food inflation is above 5 per cent in both CPI and WPI data is a concern, especially as the low base effects alone would have resulted in elevated inflation numbers even under normal conditions. A new risk has emerged in the form of rainfall uncertainty, which needs to be considered while debating the repo rate.

 

The monsoon so far has been less than normal. As of July 14, the monsoon was 21 per cent below normal levels on a cumulative basis. Twenty-seven of the 36 meteorological divisions had lower than normal rainfall, with 19 facing a deficit of above 20 per cent. While the monsoon has arrived late, there are good chances of a pickup and a likely better spread during July and August. Hence, this may not be a worry as weather patterns have changed over the last few years.  The prevalence of El Niño in the next two months has a high probability, which can come in the way of the progress of the monsoon. Given that around 40-50 per cent of the kharif output is rain-fed (the ratio of access to irrigation varies from 20-80 per cent for various crops), the monsoon is important. In fact, more than the headline number, the spread and progress are critical in determining the crop prospects.

 

The heavy rains in the last 10 days in various regions have elevated the reservoir levels to around 32 per cent of capacity, but remains below last year’s level of 52 per cent. This is important as we need to have a level close to 80-90 per cent by the end of the monsoon to provide water for cattle and crops in winter — making it another factor that the RBI MPC would need to consider seriously.  

 

As of July 10, the area under cultivation was around 48 per cent of normal, making it the lowest since 2023. This is understandable because a late arrival of rains makes farmers defer sowing. But what becomes important is the crop swapping that takes place in certain regions due to this phenomenon of delayed monsoon. The area under cultivation is lower for foodgrains, pulses, and oilseeds. Foodgrains are less of an issue as rice cultivators normally persevere with the crop due to the front-end procurement programme of the FCI. But this does not hold for pulses and oilseeds, where the prices have already shown upward tendencies. Therefore, the RBI will have to monitor the crop sowing across the spectrum as it has been observed that single crop shortfalls in oilseeds and pulses have a sharp effect on prices, and hence inflation. 

 

The market has already signaled higher prices for oilseeds and pulses. The reason is straightforward. First, the area under cultivation is lower, and the market factors in future shortfalls. Second, as pulses and oilseeds are largely single season crops, the existing stock from last year’s production tends to get reduced with time. Late sowing means late harvest, which in turn means that existing stocks have to be pulled for that much longer. All this puts pressure on prices. 

 

Keeping in mind all these factors on crop prospects, it stands to reason that rate cuts are out and an unchanged position can be expected. The OIS market is still talking of one or two rate hikes in the next nine months, but it may be useful for the MPC to probably signal in some way that a rate hike could be considered if the situation becomes grim considering that the crude oil crisis has once again popped up. Maybe change in stance or simple articulation. 

 

Disclaimer: This article is written by Madan Sabnavis, chief economist, Bank of Baroda. Views expressed are his own. Readers' discretion is advised.