The Monetary Policy Committee’s (MPC) decision to leave the repo rate unchanged would have been a tough one. It is difficult to choose between rising inflation and a sudden slowdown in economic growth. Though the MPC did lower the cash reserve ratio (CRR) this time, we expect it to go further and take the knife to the repo rate during its next policy review meeting in February.
For 21 months now, the MPC has kept rates unchanged. It continues to wait for a durable easing in the Consumer Price Index (CPI)-based inflation. The gauge has been under pressure from food prices. Over the past three months, headline CPI inflation has been on the ascent, breaching the upper limit of the MPC’s 4-6 per cent tolerance band in October.
To complicate matters, India’s growth is slackening. For July-September 2024, the country registered a GDP growth of 5.4 per cent, the slowest in seven quarters. While the second half should see a pick-up, the sharp fall in the second quarter has persuaded the RBI to revise its GDP growth forecast downward to 6.6 per cent for the current fiscal year from 7.2 per cent. Last fiscal, the MPC could afford to focus on inflation because GDP growth was a solid 8.2 per cent. But the recent slowing has increased the tradeoff with inflation. The CRR cut is an incremental step to support growth as it boosts systemic liquidity. Conducive conditions in the financial markets should support economic growth.
Monetary policies of major economies have become less restrictive in recent times. The US Fed and the European Central Bank ECB have cut 75 basis points (bps) each in 2024. But the pace of rate action has been slower than expected as taming inflation is proving to be tough for them as well. The Fed’s path to further rate cuts is unclear because incoming President Donald Trump has spoken about imposing higher tariffs, which is likely to add to inflationary pressure. S&P Global sees fewer rate cuts by the Fed in 2025 compared to what it expected three months ago.
While most emerging market central banks are likely to cut rates in 2025, they would monitor the impact of policy changes in the US on their growth and financial markets. Put another way, the global environment is conducive to rate cuts, but their pace would be slower.
The MPC’s cautious stance stems from the trends in the domestic economy, particularly as food prices remain stubbornly high. Despite a good monsoon, retail food inflation has averaged 8.3 per cent this fiscal through October. That is a good 170 basis points (bps) higher on-year.
True, retail inflation barring food has been much lower — at 2.5 per cent in April-October, a good 150 bps lower on-year. But it is food prices that typically dictate the trajectory of retail inflation in India, given its significant weight in the CPI index. Food prices also have the biggest impact on the cost of living. The higher they go, the bigger is the hole in the budgets of lower-income households.
We estimate effective inflation in the rural areas was 5.4 per cent for the bottom 20 per cent of households (by income) and 5.1 per cent for the upper 20 per cent in April-October 2024. In the urban areas, it was 4.6 per cent for the bottom 20 per cent and 4.2 per cent for the upper 20 per cent.
Food inflation has been accelerating above 6 per cent on average for almost three years now. This has cumulatively and materially increased the average monthly food bill of households. CRISIL Research estimates the monthly cost of an average vegetarian thali in October was 20 per cent higher, while the cost of non-vegetarian thali is up 5 per cent. Despite coming off a bit in November, it remains high.
As food items are frequently purchased, the inflation expectation of consumers is impacted quickly by changes in their prices. Some foods are also critical inputs for sectors such as fast-moving consumer goods (FMCG) and restaurants. So, a rise in their prices adds to the cost pressures on such businesses. Typically, they try to pass it on to consumers, adding to the overall inflation. Rising food bills have also contributed to slowing consumption in the second quarter. Leading FMCG companies have pointed this out repeatedly.
In the past two years, private consumption has slowed as food inflation rose. While it briefly surged to 7.4 per cent in the first quarter of the last fiscal, it slowed to 6 per cent in the second quarter. The urban economy faces additional headwinds from lower credit offtake and elevated interest rates. The rural economy, on the other hand, seems better placed as agricultural output is expected to be better than last fiscal year after another normal monsoon. So, while the driver of demand shifts from urban to rural, food inflation continues to be the pain point.
Healthy agriculture output this year could ease food inflation in the second half. Vegetable prices could correct sharply when the rabi, or winter, crop reaches the market. Non-food inflation is expected to remain benign amid stable non-food commodity prices. All this could spur the MPC to begin cutting rates during its review meeting in February. That said, the cumulative reduction in the upcoming cutting cycle would be less than the 250 basis points hiked since May 2022 as domestic growth momentum is projected to remain healthy and the global rate cut cycle will also be shallower.
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Given that food prices sway the retail inflation gauge, a new CPI series based on the latest consumption survey could help reassess the importance of food in shaping monetary policy decisions. Such a recalibration would decrease the weightage accorded to food in the CPI basket. Fiscal policy also needs to accelerate efforts to limit the structural and climate risks of food prices on headline inflation.
Inflation remains a concern for the Indian economy. The RBI cannot ignore this given that price stability is its main mandate. Fiscal policy mitigating supply risks can help ease food inflation durably and aid the RBI in balancing inflation with growth objectives.
Joshi is chief economist and Tandon is senior economist at CRISIL Ltd
