The Reserve Bank of India's monetary policy committee (MPC) meets this week at a time prices of vegetables like tomatoes are on the boil in the domestic market and overseas central banks like the US Federal Reserve continue to raise their interest rates. The MPC raised its benchmark repo rate back in February to 6.50 per cent from 6.25 per cent, but has since left it unchanged in the last two meetings. Will rising inflation at home and hardening interest rates overseas drive the MPC to raise rates again or will it wait and watch how things unfold, while ensuring economic growth is not hampered?
When the MPC met in June, even as the benchmark repo rate (the rate at which the central bank lends money to commercial banks) was kept on hold, RBI Governor Shaktikanta Das flagged uncertainties on the spatial and temporal distribution of monsoon and the potential impact of El Nino. He also stressed that geopolitical tensions and international commodity prices posed upside risks to inflation.
The CPI (consumer price index) inflation declined from over 6 per cent in January and February to a two-year low of 4.25 per cent in May. However, it has crept up once again; the June CPI print came in at 4.81 per cent and wholesale inflation has also risen. One of the key drivers behind the retail inflation rising again was food prices jumping from 2.43 per cent in May to 4.49 per cent in June. Looking ahead, there are signs that inflation could remain elevated. So, RBI will remain watchful of inflation. At the same time, it may not want to upset the growth momentum and hence the likely status quo for now.
Rainfall this year has been patchy. Economists at CARE Ratings note that parts of western India, including Rajasthan and Gujarat, have received surplus rain, but there has been a significant rainfall deficit in the eastern Gangetic plains till the end of July. Further, recent reports from IMD predict monsoon in August could be below normal, they added.
"The erratic monsoon has resulted in lower sowing of certain kharif crops like pulses, which could also contribute to growing inflationary pressures in the coming months. Apart from vagaries arising from monsoon and agriculture-related issues, a recent spike in international crude oil prices (11 per cent since June) due to supply cuts from OPEC countries could also put upward pressure on inflation," said Rajani Sinha, chief economist at CARE.
Therefore, the MPC is likely to remain cautious, but expected moderation in core inflation and softness in many global commodity prices could provide some comfort.
"Amid these evolving conditions, MPC members will likely take a wait-and-watch approach to better understand the nature of inflationary pressures before announcing a change in policy rate and stance," said Sinha.
Santanu Sengupta, India economist at Goldman Sachs also feels the MPC will maintain a status quo, even as its guidance will be "hawkish."
"We expect the RBI to look through the surge in food inflation, take comfort from declining core inflation, keep the policy repo rate unchanged in calendar year 2023, and continue with hawkish guidance, with Brent crude oil prices above $85 per barrel," said Sengupta, adding the central bank is also likely to retain its liquidity tightening stance.
He believes it is the government's fiscal policy that will have to do the "heavy lifting" to control food inflation as India heads into the election season.
"MPC will be concerned about the high vegetable inflation prevailing now. But, since this is due to seasonal factors, monetary policy cannot do anything about it. More importantly, there is strong growth momentum in the economy now and the MPC is unlikely to do anything that upsets the growth apple cart. So, the rates and stance are likely to remain unchanged," said V.K. Vijayakumar, chief investment strategist at Geojit Financial Services.
Rajesh Sharma, managing director at Capri Global Capital, also expects the RBI MPC to keep the repo rate on hold this time around.
"The present inflation rate in India is reported to be running at less than 5 per cent, which has provided some room for the central bank to maintain a steady monetary policy. However, there are concerns about potential upside risks to this inflation number in the forthcoming months, primarily due to the substantial increase in prices of vegetables and pulses, which should prompt the MPC to maintain status-quo on rates," he said.
The US Fed in July raised the benchmark Federal Funds Rate to a new range of 5.25-5.5 per cent and Fed Governor Michelle Bowman said further rate hikes may be needed to bring down inflation.
Earlier this month, the Bank of England also raised interest rates by 25 bps to 5.25 per cent, its highest level since February 2008.
It is largely expected that the recent spike in retail inflation will delay any potential rate cut back home and the RBI will leave the repo rate unchanged for the rest of 2023.