Wait and watch

Food prices will remain a risk for the MPC

The six-member Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) is meeting this week against a favourable economic backdrop. The official numbers released last week showed the Indian economy expanded by 7.6 per cent in the second quarter this financial year, compared to the MPC’s projection of 6.5 per cent, though RBI Governor Shaktikanta Das had said that growth would surprise on the upside. Nonetheless, the pace of expansion surprised most economists and has led to upward revisions in full-year forecasts. The MPC will also be expected to revise its forecast for the year from 6.5 per cent. Since the economy expanded 7.7 per cent in the first half, it would be interesting to see the MPC’s full-year projection. Most economists say the momentum is hard to sustain and the growth rate will come down significantly in the second half of the year.

Nevertheless, as things stand, growth is not a worry for the rate-setting committee at the moment, which allows it to focus more on inflation outcomes. The inflation rate based on the consumer price index moderated to a four-month low of 4.87 per cent in October as against 5.02 per cent in the previous month. Among the drivers of inflation, the core part, which is running close to the target, will comfort the MPC, while food prices could pose fresh challenges. In the food basket, vegetable prices moderated in October, but the inflation rate in cereals remained elevated. It’s worth noting that while prices of some vegetables are rising again, it is the prices of cereals that will worry the MPC. The latest forecast suggests the winter may be less cold this year, and this could affect rabi crops, particularly wheat. Lower rabi output — after an uneven monsoon seems to have affected kharif crops — may keep cereal prices elevated, which could, in turn, keep the headline inflation rate at higher levels. The MPC expects the inflation rate to average 5.4 per cent this financial year.

Aside from the domestic food price risk, the general environment has become more favourable. Global crude oil prices, though still at higher levels, look more stable. Tensions in West Asia, of course, remain a big risk. Inflation rates in advanced economies have come down, reducing the chances of financial market disruption, with implications for currency markets and inflation outcomes. Although the inflation rate in the US, for instance, remains above target, the risk has reduced substantially. The US bond markets, as a result, have rallied, which has brought down yields on the benchmark 10-year government bonds by about 70 basis points from the recent highs in mid-October. Although US Federal Reserve officials have said that it is premature to declare victory on inflation, and policy interest may remain higher for longer, financial conditions have eased, which has resulted in the resumption of foreign portfolio investment in markets like India. Overall, while the headline inflation rate is expected to remain above the medium-term target of 4 per cent in the coming quarters, primarily because of food prices, it makes sense for the MPC to wait and watch at this stage. From a medium-term perspective, promises made in the recent state elections, some of which may be extended to next year’s Lok Sabha elections, could increase risks for government finances, with implications for inflation outcomes.