After the release of the October inflation data, there appears to be a broad consensus that the RBI’s monetary policy committee will vote to keep interest rates unchanged when it meets in December. After all, inflation is now above the upper threshold of the central bank’s inflation targeting framework. But the question is whether the RBI’s actions are being influenced solely by concerns over inflation or are other considerations dominating.
The commentary from the central bank suggests that it is worried about high food inflation spilling into core inflation through the wage-price spiral. This concern is misplaced on two counts.
First, much of the recent surge in food prices has been driven by vegetables. Excluding vegetables, headline inflation was just 3.3 per cent in September and 3.6 per cent in October, indicating that underlying price pressures are non-existent. And it isn’t as if this surge caught the central bank by surprise. This risk was explicitly articulated by the RBI Governor in his comments on the last monetary policy meeting in October: “The CPI print for the month of September is expected to see a big jump due to unfavourable base effects and pick up in food price momentum.” Further, food prices are expected to cool down once the fresh harvest arrives. The outlook for the rabi crop is also promising. The RBI also expects food prices to ease later in the year.
Second, it is typically “large” and “persistent” food price shocks that tend to impact non-food prices. And, so far, there is no evidence of a wage-price spiral. Labour markets remain weak, not tight. Many more are now engaged in the agricultural sector in the absence of more productive non-farm employment opportunities. Workers have less bargaining power. Wage growth has been muted and farm input costs remain low. Core inflation remains subdued. All this perhaps also explains why the central bank retained its inflation forecast in the October MPC meeting despite the expected surge in food prices.
Then there is the issue of growth. The central bank has argued that the strength of the economy has created space for the MPC to keep monetary policy this restrictive. Its commentary continues to be remarkably upbeat about growth prospects — it has kept its GDP growth forecast unchanged — despite concerns that several indicators are pointing towards the momentum slowing down. The RBI’s rather optimistic assessment is also at odds with that of the government. The uncharacteristic frankness with which the more recent monthly reviews of the Finance Ministry have drawn attention to some of the pain points — from “incipient signs of strains in certain sectors” to “moderation in urban demand” — is quite telling for a government that is always keen to project the strength of the economy, no matter its actual state. The pressure to cut rates is now coming from the government as well.
There is, however, a remarkable underappreciation of how deep the slowdown could possibly be. The momentum in the economy, which was for some time being powered by the boom in global capacity centres and the consequent demand for real estate and cars, among others, appears to be petering out. Worryingly, there are no internal drivers of growth. Private-sector investment is yet to pick up. Broader household demand remains weak — a consequence of lack of job opportunities, subdued wages, and high food inflation eating into the consumption basket. Consumption by the more affluent can no longer mask it. In fact, weak household demand is why core inflation has been so subdued. Real GDP growth is likely to fall below 7 per cent this year, down more than 1.2 percentage points from 8.2 per cent last year. Nominal GDP growth could be below 10 per cent for the second straight year. The economy is in search of new drivers of growth.
In such a scenario, considering the lags with which changes in monetary policy reflect in the broader economy, can, or rather, will the RBI look beyond the surge in vegetable prices? After all, what matters for monetary policy is expectations of inflation a few quarters down the road, and those don’t seem to have changed significantly.
At the moment, it does not seem likely that the RBI will change its position, at least, in the coming weeks. Other factors are now at play. Currency considerations, rather than inflation concerns, are likely to dominate. The election of Donald Trump has changed the calculus.
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Since September, the US Fed has cut the short-term rate by 75 basis points. Despite that, long term rates have edged upwards. Under a second Trump presidency, expectations of higher tariffs, which will be inflationary, and tax cuts, which will increase deficits, have pushed the 10 year-US treasury yield to 4.44 per cent, up from 3.61 per cent a few months ago. Views that the Fed may not cut interest rates by as much as was previously believed have gained traction. Comments from Fed chair, Jerome Powell, signal this as well. Higher interest rates serve as a tailwind for the dollar. Foreign investors have also pulled out close to $14 billion from the Indian stock markets over the past two months. All this has put the rupee under immense pressure.
For some time, the RBI has been trying to hold the line on currency. Though, of late, it has given up a bit. Cutting interest rates now would lead to further capital outflows, and weaken the currency. While such a fall could help improve export competitiveness, possibly providing a boost to the sagging economic momentum, there is another issue. A falling currency works against some of the country’s biggest corporate groups who have taken huge amounts of foreign currency loans.
Perhaps after early December, the central bank leadership, which is trying to navigate a challenging economic and political environment, will be surer of the direction of policy and change tack on interest rates and the currency.
ishan.bakshi@expressindia.com
