RBI monetary policy: The tide is turning

Six important developments have occurred since the Reserve Bank of India (RBI’s) June Monetary Policy Committee (MPC) meeting.

First, the global backdrop. We are now in the midst of a more broad-based global policy easing. The US Fed has moved back from a single inflation mandate to its dual mandate. The weak US July employment report has re-ignited the US soft landing/hard landing debate. US yields have tumbled, financial conditions are tightening, and the question now is how soon the Fed will move. “Higher for longer” has now become a thing of the past.

Second, commodity prices are easing. Geopolitical risks persist in West Asia, but the sustained domestic demand weakness in China and growing concerns over the US economic outlook could easily offset these pressures. Since the RBI’s June MPC, broader commodity prices have fallen by nearly 6 per cent, which is easing input cost pressures from earlier this year.

Third, food inflation is high and remains an irritation, but it should cool. Nearly 50 per cent of food inflation in June was led by vegetables, which have short six-month cycles; their prices should reverse as fresh arrivals pick up. Monsoon rains are projected to be above normal in August-September, and higher reservoir levels bode well for winter crops. The CPI excluding vegetables rose by just 3.5 per cent year-on-year in June, which suggests the rise in headline inflation is narrowly driven.

Fourth, underlying price pressures remain contained. On a three-month seasonally adjusted annualised rate basis, core CPI, super core (excluding petrol, diesel, gold, silver), core goods and core services inflation all rose by just 2.1-2.7 per cent in June, and they have now remained below 4 per cent for a year. Despite repeated food price shocks, fears of a spillover to core inflation has not materialized. In our view, this suggests inflation expectations are well anchored and we see this as a sign that inflation is aligned to the 4 per cent target. Higher telecom tariffs and adverse base effects will push year-on-year core inflation higher ahead, but it should average closer to 3.5 per cent in 2024-25.

Fifth, the wide credit-deposit rate gap should correct over coming months, due to the RBI’s tighter macroprudential norms. Bank lending to NBFCs and unsecured lending is slowing, which is a trend we expect to sustain. Higher fixed deposit rates should mean that the moderation in credit growth will outpace the moderation in deposit growth, bringing the credit-deposit gap into better balance.

Finally, growth signals are mixed. High-frequency data show that rural demand is improving from its lows, but MHCV and passenger vehicle sales disappointed in July. The latter are important cyclical indicators and are signaling a potential growth cycle moderation ahead. On the whole, we expect gross domestic product (GDP) growth of 6.9 per cent in FY25, but downside risks have increased, due to weakness in US growth and tighter financial conditions.

Ultimately, the RBI’s monetary policy should be driven by domestic factors and not the Fed. Domestic core inflation remains well anchored, food inflation should ease and emerging global developments suggest rising downside risks to domestic growth and inflation next year. Given monetary policy works with long lags, why wait to signal that a policy pivot is ahead?

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