Why RBI has kept policy rates unchanged

Why has RBI kept the rates unchanged?

The overall economic outlook remains upbeat despite some challenges in specific sectors. While there has been broad-based moderation in inflation, higher food inflation keeps headline numbers elevated. However, benign core inflation will comfort RBI as strong growth has mainly remained non-inflationary.

While announcing the monetary policy RBI Governor Shaktikanta Das said as the uncertainties in food prices continue to pose challenges, the MPC remains vigilant to the upside risks to inflation that might derail the path of disinflation.

“Two years ago, around this time, when CPI inflation had peaked at 7.8 per cent in April 2022, the elephant in the room was inflation. The elephant has now gone out for a walk and appears to be returning to the forest. We would like the elephant to return to the forest and remain there on a durable basis,” the Governor said.

In other words, he said, it is essential, in the best interest of the economy, that CPI inflation continues to moderate and aligns to the target on a durable basis.

“Till this is achieved, our task remains unfinished,” Das emphasised.

The RBI has indicated that headline inflation will moderate in the coming months, aided by a favourable base effect lasting until July 2024. The arrival of rabi harvests in the market along with expectations of a normal monsoon next year will also alleviate pressure on food prices.

The RBI will thus be inclined to adopt a cautious approach, preferring to assess the evolving risks associated with food inflation before making any changes in its decisions in the coming policies.

As guided by the March monetary policy bulletin, monetary policy will remain in “risk-minimisation mode” to align inflation towards the target while supporting growth. Given that the RBI Governor has been highlighting the aim of getting inflation to 4% on a durable basis, the policy rates are likely to be kept on hold for some more months – probably till October 2024 — with no change in stance.

Headline inflation has eased significantly from 5.7% in December to 5.1% in January and February. The fall in overall inflationary pressures over the past couple of months has been broad-based, with core inflation consistently trending downward, remaining below the 4% threshold for three consecutive months.

However, the food and beverages inflation remain elevated, with a 7.8% increase in February, led by price pressures in vegetables (30.3%), pulses (18.9%), and spices (13.5%), according to CareEdge Ratings.

On estimate of GDP growth

The RBI has retained the GDP growth forecast at 7 per cent in FY25 as against 7.6 per cent growth projected by the NSO for FY24. It has projected a growth of 7.1 per cent in the first quarter of FY25, 6.9 per cent in Q2 and 7 per cent each in Q3 and Q4. Headwinds from geopolitical tensions, volatility in international financial markets and geo-economic fragmentation pose risks to the outlook.

“The headwinds from protracted geopolitical tensions and increasing disruptions in trade routes, however, pose risks to the outlook,” Das said.

On the growth front, the government recently released the Q3 GDP print, which noted the economy has accelerated by 8.4 per cent from 8.1 per cent in Q2FY24, signaling the economy has been on a strong footing.

The resilience in the domestic economy has been supported by a robust manufacturing sector which continues to grow in double digits. Furthermore, investment continues to grow at a steady pace and bodes well for the economy.

RBI’s inflation forecast

The RBI has projected a retail inflation of 4.5 per cent in fiscal 2024-25. It has projected an inflation of 4.9 per cent in Q1, 3.8 per cent in Q2, 4.6 per cent in Q3 and 4.5 per cent in Q4 of FY25.

Das said frequent and overlapping adverse climate shocks pose key upside risks to the outlook on international and domestic food prices.

Sustained inflationary trend in nonperishable food categories, such as pulses and spices, raises concerns about the potential broadening of price pressures due to their inherent stickiness.

However, it is worth noting that supply-side interventions have played a pivotal role in tempering prices, particularly in cereals. Disinflationary trends in cereal inflation are evident, with a decline from an average of 10.3 per cent in Q3 FY24 to an average of 7.7 per cent in the months of January and February.

The recent uptick in global commodity prices also warrants close monitoring, with Brent crude and industrial metal prices up 4.4 per cent and 5.5 per cent since the last MPC meeting.

On lending, deposit rates

Interest rates on loans and deposits are largely likely to remain unchanged as of now. All external benchmark lending rates that are linked to the repo rate will not rise. It will provide some relief to borrowers as their equated monthly instalments (EMIs) will not increase. However, as banks are under pressure on the deposit growth front due to competition from mutual funds for funds, deposit rates are likely to rise in certain buckets.