The RBI is cautious and could have trouble lowering rates before the US Fed

 The RBI is cautious and could have trouble lowering rates before the US Fed

The RBI is cautious and could have trouble lowering rates before the US Fed

According to Indranil Pan's analysis of growth-inflation dynamics, the RBI may only have an opportunity to lower rates in the vicinity of the August 2024 policy.

By Yes Bank Chief Economist Indranil Pan

With rapid growth that has beyond all forecasts and somewhat under control inflation dynamics, India seems to be in a good place. This program was implemented in the context of moderate inflation, mostly due to growing vegetable costs. We cannot imagine the worst of the effects. The market continued to be concerned about ex-policy since the RBI has a history of surprising people with its actions on liquidity rather than interest rates.

While several central banks globally bloated their balance sheets in an attempt to combat the COVID-19 pandemic, most of them absorbed surplus liquidity as things stabilized. RBI followed suit, and despite the ineffectiveness of its conventional instruments, it shocked the market in August by announcing the I-CRR and permitted OMOs to take on liquidity in the October policy. presented as a tool for. Fortunately, the market was not taken aback by this move.

However, the market views this policy as a little lenient. In addition, the Governor's speech emphasized that the RBI must be aware of the "risk of excessive tightening." This is the first time that the RBI has decreased the risk of any imminent OMOs (open market operations). The governor, however, shot down the notion that the RBI will take a "neutral" policy position anytime soon at the news conference.

RBI wants to drive cautiously, pay close attention to any speed bumps up front, and perhaps prevent any accidents. "The Governor notes that policymakers must be wary of being sidetracked by a few months of strong data or the fact that CPI inflation has moved into the target range." This is most likely the case globally, and despite the fact that US inflation data have begun to decline, the US Federal Reserve is adamant about maintaining its accommodating policy.

Crucially, the integrity of the inflation target rate has become more well-known in global monetary policy decisions. The Reserve compliments itself and its policy decisions, stating that core inflation has decreased by raising policy rates, tightening liquidity, and placing inflation ahead of growth. Monetary policy is working as intended. However, the 4 percent goal remains unattainable. The RBI has kept its inflation forecasts for the third and fourth quarters of FY24 at 5.6% and 5.2%, respectively, with no modifications.

Inflation is now expected to be 5.2% for Q1 FY25 (unchanged from the prior assessment). The RBI projects Q2 FY25 inflation to reach 4.0%, however this will mostly be because of base effects from the previous year. Furthermore, the Q3 FY25 inflation rate has returned to 4.7%. As a result, it seems that the window of opportunity for lowering policy interest rates is somewhat narrow.

There are several problems at hand. First, core inflation is steadily declining and now stands at 4%. But keep in mind that the RBI increased its forecast for GDP growth in FY 2024 from 6.5 percent to 7%. Furthermore, the RBI projects that GDP growth would average 6.5% throughout the first three quarters of FY2025, indicating that the momentum is still robust. Whether the potential growth has actually expanded so quickly in response to different government initiatives is the contentious subject here. If not, are there indications that the economy is warming up, something I doubt has happened? Furthermore, it is quite unlikely that inflation would consistently drop to the target level if potential growth is less than 6.5%.

Pricing is still vulnerable to supply-side factors for the time being. Global supply networks have undergone significant transformations, and uncertainties are created by ongoing developments in the geopolitical and geoeconomic spheres. Global climate change is a problem, and there are still issues with food availability. Globally, as the population ages, dependence ratios are increasing and savings and investments are decreasing. This is also giving rise to worries of worldwide fundamentally rising inflation.

Finally, problems related to climate change have sparked worries about inflation in local food prices closer to home. Around July or August, we recovered from the tomato shock, but as of right now, prices for potatoes, onions, and tomatoes are once again quite high. Both pulses and grains are causing headaches for some people. Furthermore, as stated by the RBI itself, "uncertain food prices will significantly influence the inflation outlook going forward." Already, the RBI has projected higher inflation figures for November and December. Additionally, the Rabi sowing is still modest, and it is important to monitor the rise of pressures related to food prices in the coming months.

The RBI will likely maintain sufficient liquidity levels, neither so high as to encourage inflation nor so low as to temporarily raise interest rates and impede economic expansion. The fact that the RBI has immediately decreased the likelihood of OMO but hasn't completely eliminated it is good news for the market. It would be very challenging to continuously forecast liquidity under the present uncertain situation, and the amount of global flows to India will have a major influence.

The Governor said at the press conference that there is good news spreading across India and that the country will begin to reap the benefits of the bond index inclusion in June 2024. Yet, OMO may be a helpful tool and certain flows may be what cause this occurrence. That moment. The modest difference in interest rates between the US and India might potentially inspire the concept of OMOs. Recall that, in October 2023, US interest rates were climbing but the yields on Indian bonds were not rising much. Presently, US yields have decreased more quickly than Indian ones, and this difference has grown, decreasing the likelihood of an instantaneous OMO.

The "longer higher" tale is still relevant as a result. Since there is still an interest rate difference between the US and India to support the rupee, it could be challenging for the RBI to lower rates before the US Fed. Based on our analysis of the growth-inflation dynamics, we believe that the RBI may only be able to lower rates in the vicinity of the August 2024 policy.