Monetary policy preview: If it ain't broke, don't fix it

It’s hard to believe, but true.

For the first time in recent memory, core inflation is falling despite robust growth. The dominant narrative puts it down to a rise in India’s ability to grow, which economists call potential growth.

But some other factors may be at play.

One, China seems to be exporting disinflation. Increases in wages are slowing, and export prices are falling. The Chinese currency has also become far more competitive, so it’s no surprise that China’s export volumes are rising.

India, meanwhile, has ramped up imports of consumer goods and is likely importing some of this disinflation.

Two, commodity prices eased in 2023-24, allowing producers to cut output prices while maintaining profit margins.

Three, India’s two-speed consumption means demand for services, which bottom-of-the-pyramid households consume more of when incomes rise, is weak; and this is keeping services inflation below goods inflation.

India is a standout economy where the stickier services inflation is running below goods inflation.

A case for monetary policy easing can be made.

Core inflation is falling, and the rupee is stable. But the more pertinent question here is whether there is a need for monetary easing. Let’s discuss the key determinants.
 

Growth slack? It’s complicated.

Gross domestic product is 4 per cent below the pre-pandemic trend, and strong growth may just mean that the slack in the economy is disappearing (rather than potential growth rising). If that’s indeed the case, there may be no pressing need to cut rates from the perspective of growth.

Neutral rates? It’s not directly observable. There are uncertainties over where equilibrium rates should be, especially given the large economic changes since the pandemic.

 However, it is worth noting that real rates at present (at about 2 per cent) do not seem to be restrictive. They are where they were in the pre-pandemic period. And credit growth remains strong, which means that high rates are not coming in the way of financial activity.

If potential growth rises from here, it would mean the economy’s neutral rate should only rise. All said, there’s no urgent case for rate cuts from a neutral rate perspective.

Inflation? It’s not at target.

Core inflation has fallen to 3.7 per cent, but food inflation is at 7.8 per cent, and amongst the highest in Asia. Add to that the 9 per cent rise in oil prices in recent months, and once again, there’s no urgent need for rate cuts.

Macro-prudential tightening? It’s ongoing.

The Reserve Bank of India (RBI) increased risk weights on certain fast-growing loan categories in November 2023 to curb excesses. It could be counterproductive to ease rates when the macro-prudential measures haven’t fully percolated.

Liquidity? It’s already eased.

Overnight rates have softened by 10-20 basis points over the past month. As the government spends during the end of March, liquidity could ease further in April. 

As such, any urgent need for easing already seems to have been addressed.

So, the growth slack is likely closing, neutral rates may rise over time, and inflation is not yet at target levels. Food and oil prices are elevated, and macro-prudential tightening is still percolating through the system.

Does the RBI need to cut rates and ease its hawkish stance on April 5? We think not. Let’s not fix what’s not broken.

The writer is the chief India and Indonesia economist and managing director (global research) at HSBC. Views are personal