A pause with abundant caution

After a spell of brisk rate hikes during the large part of 2022-23, the Monetary Policy Committee (MPC) surprised the market by keeping the repo rate constant at 6.5 per cent in April. The pause by the Reserve Bank of India (RBI) was vindicated by softening of consumer price index (CPI) inflation to around a level of 4.5 per cent during the summer months. Subsequently, the RBI continuing with a pause on the repo rate in June was no surprise.

However, since then, inflation has surged again. We estimate headline CPI for July (scheduled for release in mid-August) to reach 6.6 per cent year-on-year (Y-o-Y) from 4.8 per cent a month back. Second, importantly, after a pause since January 2023, the US Federal Reserve hiked the policy rate in July and continues to guide for at least one more hike this year. These developments have clearly increased curiosity around the outcome of the August MPC meeting.   

We examine these two factors a bit more closely. Despite the current surge in CPI inflation, bulk of the rise came from food prices rather than in a broad-based fashion. In our estimate, of the likely about 175 basis points (bps) rise in CPI inflation in July, contribution of food items was more than 150 bps, of which vegetables alone may have contributed over 135 bps. No other segment made a large contribution. Typically, price spikes of the current nature often soften in two-four months. Accordingly, unless the ongoing weather disruption worsens further in the coming months, the current surge in CPI may start tapering by the next quarter. Importantly, WPI (wholesale price) inflation averaged a drop of 2.8 per cent Y-o-Y during 2023-24 so far, reiterating that inflationary pressures are modest beyond the food items.

As regards global monetary policy trends, the US Fed guided in June for a cumulatively 50 bps hike in the Fed Funds Rate (FFR) during the remaining months of 2023. Thus, the 25 bps hike by the Fed in July was no surprise. However, while two of the 18 Fed Governors in June preferred no further hike during the remaining months of 2023, all the 18 governors voted for a hike in July. It means that the two Fed governors who had favoured a pause on the FFR during 2023 six weeks ago, had voted for a hike in July. In sum, the Fed’s actions look set to stay data dependent as the central bank has kept all their options open for the coming months. The action and guidance of the US Federal Reserve in September will play a crucial role in influencing the global policy rate cycle, including that of India in October.

Finally, one feels that the status quo maintained by the RBI on repo rate in recent months was the most appropriate and commendable decision, demonstrating a more “Fed-independent” monetary policy stance, partly bolstered by the cushion of a material narrowing of trade and current account gaps and a range-bound rupee. The currency movement around that time could also have a material bearing on the RBI’s rate decision in October.

On balance, while the MPC will surely reiterate their strong vigil on inflation and the fact that another hike in the coming months cannot be ruled out, my baseline expectation firmly remains that of a pause in August as the RBI should look through the current bout of inflation.

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The author is chief economist & head of research at Bandhan Bank. Views are personal.