Encouraging outlook

Inflation is expected to ease in the coming quarters

The last policy review of 2023 by the Reserve Bank of India’s Monetary Policy Committee (MPC) was widely expected to leave the policy rate and stance unchanged. The committee rightly decided not to surprise the markets on Friday and ended the year on a satisfactory note. In fact, the year turned out to be much better than expected. It started with heightened levels of uncertainty, with very high inflation rates in advanced economies and central banks struggling to cope with them. It was not clear for how long inflation rates in some of the advanced economies would remain elevated and how markets would react to sustained policy tightening by large central banks. It is worth noting that the world had witnessed significant financial and currency-market volatility as a result of policy tightening by large central banks, particularly the Federal Reserve, in 2022. As 2023 is coming to an end, inflation rates in advanced economies, though above target, have moderated considerably. Although the Fed has indicated that the policy interest rate will remain higher for longer, financial conditions have eased considerably.

Growth outcomes have also been better than expected. The US, for example, has evaded the much-anticipated recession thus far, while India has grown at rates above expectations. Thus, the financial markets on Friday were more interested in the MPC’s revised growth projection. The gross domestic product numbers for the second quarter this financial year, released recently, showed the economy expanded 7.6 per cent, taking the growth rate in the first half of the financial year to 7.7 per cent. Accordingly, the MPC revised its growth projection for the year to 7 per cent. The committee expects the economy to expand 6.5 per cent and 6 per cent in the third and fourth quarters, respectively. It also expects the growth rate to remain above 6.5 per cent in the first half of 2024-25. Maintaining growth at around 6.5 per cent over the next one year would be commendable.

On the inflation front, the MPC expects the inflation rate to average 5.4 per cent this financial year. While the rate will remain significantly above target in the current year, the committee expects it to come down to 4 per cent in the second quarter of 2024-25 before moving up to 4.7 per cent in the third quarter. With inflation rates moderating globally, and a comfortable level of core inflation, it’s the increase in food prices that would pose a challenge. The headline inflation rate, for instance, is expected to increase in November and December, largely because of higher vegetable prices. While the MPC will sit out the spike, which is a sensible thing to do because spikes in vegetable prices tend to be short-lived, it is the cereal prices that will need to be carefully watched.

The government has restricted exports of several items, which has helped contain inflation, but lower production due to weather-related issues could keep prices elevated. Overall, while global factors, such as geopolitical tensions, will continue to pose risks to the Indian economy and global growth is likely to remain below trend in the medium term, risks from financial markets have eased considerably. In fact, the outlook for the next few quarters looks better than it has been over the past several years. Domestic outcomes would also be influenced by policy changes, both before and after the 2024 Lok Sabha elections.