When the Reserve Bank of India's (RBI) monetary policy committee met last in April, inflation was still above target, GDP growth was expected to slow and more importantly risks to the financial system had risen amid a few bank failures in the US. In this backdrop, the MPC, contrary to expectations of a repo rate hike had chosen to pause.
Two months since, inflation is well below the upper end of RBI's 2 per cent to 6 per cent tolerance band, GDP growth in the January-March quarter surprised on the upside and financial market conditions have stabilised. Not, surprisingly then, the RBI MPC expectedly left the repo rate, the benchmark rate at which it lends central banks, on hold at 6.50 per cent.
The decision to leave interest rate unchanged was unanimous. The MPC also decided by a majority of five out of six members to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth.
"The MPC recognised that the pace of global economic activity is expected to decelerate in 2023, dragged down by elevated inflation, tight financial conditions and geopolitical tensions. The pace of monetary tightening has slowed in recent months, but uncertainty remains on its future trajectory as inflation continues to rule above targets across the world," said RBI Governor Shaktikanta Das.
Back home, after remaining over 6 per cent in January and February, retail inflation fell below RBI's target band to 5.66 per cent in March and further softened to 4.7 per cent in April, an 18-month low.
While this suggests that monetary steps taken by the central bank to control inflation and supply side measures have worked, there are uncertainties that remain on how it will pan out in the months ahead. The arrival of monsoon is already delayed by a few days and if and how much of an impact will El Nino conditions have on the rainfall needs to be closely watched out for.
"The forecast of a normal south-west monsoon by the India Meteorological Department (IMD) augurs well for the kharif crops. Uncertainties, however, remain on the spatial and temporal distribution of monsoon and on the interplay between El Nino and the Indian Ocean Dipole (IOD)," noted Das.
He further stressed that geopolitical tensions; uncertainties around the monsoon and international commodity prices, especially sugar, rice and crude oil; and volatility in global financial markets pose upside risks to inflation.
Not surprisingly, the RBI has projected retail inflation will remain above 5 per cent in the current financial year ending March 2024.
The central bank sees full year 2023-24 consumer price index (CPI) inflation at 5.1 per cent, marginally lower than the 5.2 per cent it had forecast in the last MPC meeting. Inflation is expected to average 4.6 per cent in April-June, 5.2 per cent in July-September, 5.4 per cent in October-December and 5.2 per cent in Jan-March quarter of 2024.
On the growth side, Jan-March GDP surprisingly grew at 6.1 per cent, significantly better than 4.4 per cent recorded in the October-December quarter of 2022. The strong Jan-March growth print, drove the full year 2022-23 GDP growth to 7.2 per cent, higher than the earlier estimated 7 per cent.
Looking ahead, Das said that domestic demand conditions remain supportive of growth on the back of improving household consumption and investment activity. While urban demand remains resilient, rural demand is also on a revival path, he pointed.
Higher rabi crop production, expected normal monsoon, continued buoyancy in services, and softening inflation are expected to support household consumption, felt Das. At the same time, healthy balance sheets of banks and corporates, and normalisation of supply chains augur well for the capital expenditure cycle to gain momentum, he opined. Also, robust government capex is expected to nurture investment and manufacturing activity.
"The headwinds from weak external demand, volatility in global financial markets, protracted geopolitical tensions and intensity of El Nino impact, however, pose risks to the outlook," said Das.
For now, the RBI has retained its GDP growth forecast for 2023-24 at 6.5 per cent. The GDP growth in April-June quarter is seen at at 8.0 per cent; it is expected to be at 6.5 per cent in July-September; 6.0 per cent in October-December and at 5.7 per cent in Jan-March of next year.
Things look "resilient" on the external front too, according to Das. In the current financial year, up to June 6, foreign portfolio investors had invested $8.4 billion in India's capital market, the rupee has remained largely stable since January 2023 and foreign exchange reserves were at a "comfortable" $595.1 billion as on June 2, 2023. Including net forward assets forex reserves are well above $600 billion, said Das.
On the one hand, easing inflation, bounce back of growth, gives the confidence that the policies are on the right track, Das said. But, he added the central bank will have to remain "watchful" and "proactive" in dealing with emerging risks to price and financial stability, as it moves to the primary target of 4 per cent inflation.
"Given the uncertainties, we need to maintain Arjuna’s eye on the evolving inflation scenario," pointed Das, adding it is always "the last leg of the journey, which is the toughest."
All eyes will be on the monsoon now and everyone including the RBI will be hoping that El Nino conditions don't have a severe impact on the rains this year. Ongoing geo-political tensions and how growth pans out in major economies around the world this year, will also have a bearing on the domestic services sector and export-oriented sectors.
