The upcoming Monetary Policy Committee meeting comes amidst challenges. CPI inflation in the last two months has shot up above RBI’s upper tolerance band of 6%. While India has recorded healthy GDP growth of 7.8% in Q1, there are concerns around growth moderating in the coming quarters. Moreover, the global environment remains precarious amidst weak economic growth, rising global crude oil prices and expectations of global interest rates remaining higher for longer.
The recent escalation in CPI inflation has been mainly because of a spike in food inflation, to be more specific vegetable inflation. Due to weather related disturbances, vegetable inflation shot up to high double-digit levels, resulting in overall food inflation rising to 9-10% in July-August.
With the supply situation improving, vegetable prices have already started moderating and this will help moderate food inflation in the coming months. However, the concerning aspect is that inflation in many other basic food items like cereals, pulses and milk continue to remain high and that could put pressure on household inflationary expectations. The skewed monsoon distribution and the subsequent adverse impact on kharif sowing has further aggravated food inflation concerns.
With the monsoon in Eastern and Southern part of the country being in deficit, sowing of crops like pulses and oilseeds are lower by around 5% and 2% respectively, compared to last year. This is concerning as it comes in the midst of already high food inflation. However, the comforting factor is that core inflation in the economy has been moderating and has gone below 5% in August. WPI inflation, which has less weight of food items, has been contracting in the last few months.
Overall, we expect CPI inflation to moderate from 6.9% in Q2 FY24 to 5.6% in Q3 and 5.1% in Q4. With CPI inflation in the second quarter turning out higher than RBI’s projection, the Central Bank is likely to revise upwards the inflation projection for FY24 to 5.6% (from current projection of 5.4%). The upside risks to inflation could come from higher food inflation. While the spike in global crude oil prices is concerning, it may not result in upward pressure on retail fuel prices in the near-term, as there will be pressure on Oil Marketing Companies (OMCs) to absorb the price rise.
As far as economic growth is concerned, some of the leading indicators like GST collection, e-way bills, passenger vehicle sales continue to record healthy growth. Consumption GDP recorded healthy growth of 6% in Q1 FY24 from 2.7% in the previous quarter. However, the concern is that the consumption recovery is not very broad-based as indicated by relatively weaker demand from rural regions. Poor monsoon and high food inflation could further dampen rural demand recovery.
On the Investment front, growth is being mainly led by the Government sector. While the private sector is showing increasing intent to invest, actual investment remains relatively weak. Merchandise Exports that have been contracting in the last few months are likely to remain weak. Overall, GDP growth is expected to moderate in the subsequent quarters, not just because of domestic and global challenges, but also because of statistical base effect. RBI is likely to maintain the GDP growth projection at 6.5% for FY24, even with the renewed headwinds to growth.
The external environment will remain challenging with global growth likely to slow in 2024. The US economy may be able to avoid technical recession, but there are severe concerns around China’s recovery, even while EU region economic prospects remains feeble. With inflation still above the Central Banks’ target for most developed economies, global interest rates are likely to remain higher for longer. This could have an adverse impact on capital inflows into emerging economies including India. Moreover, India’s current account deficit is likely to widen to 1.8% of GDP in FY24 (from our earlier projection of 1.6%), if global crude oil prices remain above US$ 90/ bbl.
With increased forex intervention by RBI, the forex reserves have slipped below US$ 600 billion, but still remain adequate. While the external environment warrants caution, India is still comfortably placed supported by healthy services exports and remittances inflows.
Given that the recent inflationary pressure is transient in nature, RBI is likely to maintain status quo on policy rates. However, the Central Bank will remain cautious and maintain the stance as withdrawal of accommodation, given the looming risks to inflation.
Banking system liquidity has tightened, moving to a deficit in September from surplus during the August Monetary Policy Committee meeting. Going forward, while the Central Bank will ensure enough liquidity to support credit demand, liquidity management will be geared towards avoiding any buildup of a large surplus. So even while the Central Bank is unlikely to hike rates, they may use liquidity management tools to keep short-term rates higher in the near-term. The Central Bank is likely to consider rate cuts from Q2 FY25 as inflationary risks abate.
