The RBI’s Monetary Policy Committee (MPC) changed its stance to “neutral” but kept the policy rate unchanged. Undoubtedly, high food inflation has been a major constraint to wielding the scalpel. Non-food inflation stayed significantly below trend at 2.3 per cent in August, which, incidentally, matched the average of the first five months of this fiscal. We expect the MPC to cut the policy rate by 25 basis points (bps) during its December review meeting as food inflation is likely to ease. A significant upside to non-food inflation is unlikely unless geopolitical tensions intensify and affect shipping, crude oil supply and commodity costs.
Global monetary policy signals have turned favourable after the US Federal Reserve (Fed) cut its funds rate by a chunky 50 basis points bps in September — the first such move in four years. That signalled the decisive turn in the monetary policy cycle among systemically important central banks. The European Central Bank (ECB) and the Bank of England had sliced rates earlier. We expect the Fed to cut rates by another 50 bps this year, followed by another 125 bps in 2025.
The Fed’s rate cut typically triggers capital inflows into emerging markets and creates an appreciation bias for the recipient country’s currency as the interest rate premium over the US rate widens. This provides the central banks in emerging markets wiggle room to adjust their monetary policies to support growth. But the pace and direction of rates will be largely influenced by domestic dynamics of growth and inflation.
Some emerging markets had already begun front-running the Fed by cutting rates. Within Asia, the Philippines and Indonesia initiated rate cuts prior to the Fed move, and now have additional room for further reductions. Interestingly, Brazil, which had aggressively cut rates before the Fed, has had to move the other way because its economy was overheating and creating inflationary pressures. This is an instance of emerging-market monetary policy responding more to domestic than global conditions.
The Fed’s move has created space for the RBI to cut. In the most recent rate hike cycle, the Fed had hiked interest rates by 525 bps, whereas the RBI has raised only 250 bps. Inflation was a bigger problem in the US.
The gap between US and Indian policy rates, which was narrower than historical levels at the start of this fiscal, became wider with initiation of the US rate cut in September. Consequently, capital flows to India increased and the rupee has strengthened. S&P Global notes that this time, the impact of Fed rate cuts on capital inflows will be more pronounced in Asian emerging markets, particularly ones with healthy macroeconomic performance. Add to that India’s inclusion in global bond indices — with the FTSE being the latest — and capital inflows are bound to be robust.
That said, domestic consumer inflation remains the key determinant for the RBI’s decisions. Mint Road has time and again reiterated its intent of aligning consumer inflation to its long-term target of 4 per cent on a durable basis. The word “durable” is the key, as a temporary decline in inflation to the target, as we saw in July-August, is unlikely to trigger a rate cut. During July-August, headline inflation dropped to an average of 3.6 per cent. Although keeping the interest rates high does not bring down food inflation, RBI cannot ignore high food inflation. With food and beverages having about 46 per cent weight in the consumer basket, overall inflation cannot be tamed at 4 per cent without a benign food inflation scenario. Past data confirms this.
Also, if food inflation is elevated in a high-growth environment, it can morph into generalised headline inflation. The RBI expects the Indian economy to grow 7.2 per cent this fiscal over a high base of 8.2 per cent last fiscal, a tad higher than CRISIL’s forecast of 6.8 per cent. The transmission from food to overall inflation can occur through high inflationary expectations, leading to a wage-price spiral. An RBI study this year noted that high food inflation is influencing the inflation perceptions and expectations of households, with potential spillovers into non-food prices.
Non-food inflation stayed soft at 2.3 per cent in August, with core inflation at 3.3 per cent and deflating fuel prices. We do not see a significant upside to non-food inflation, as the slowing global economy will keep commodity prices subdued. S&P Global has reduced China’s GDP growth forecast to 4.6 per cent for the current year. US GDP growth is expected to slow to 1.8 per cent in 2025. The S&P Global-GEP Supply Chain Volatility Index shows that spare capacity is rising worldwide, more so in North America and Europe than in Asia. The tensions in the Middle East have added uncertainty to crude prices and supply-chain movements.
Food inflation is the trickiest and is becoming unpredictable with changing rainfall patterns and rising climate risks. The good news is that foodgrain inflation is softening due to plentiful rains. The monsoon ended with overall rainfall 8 per cent above normal during June-September. The progress in sowing augurs well for kharif food grain output. Improved reservoir levels and recharged groundwater should support rabi production. Vegetable inflation continues to be a worry, with tomato prices fluctuating and potato and onion prices remaining firm in the TOP (tomato, onion and potato) category, according to the latest data. Potatoes were impacted by blight, and onions by poor rabi output this year. Notably, vegetable prices deviated from their typical decline during winter months in 2023 due to persistent shocks from inclement weather, be it abnormal rainfall or heat extremities. This year, we expect things to improve as vegetable inflation should ease in winter months with the arrival of a fresh harvest.
A combination of moderate non-food inflation, cooling food inflation, and US Fed rate cuts will pave the way for India’s rate cuts to start in December.
The writer is Chief Economist, CRISIL Ltd
