In his recent monetary policy statement, Reserve Bank of India (RBI) Governor Shaktikanta Das reiterated the central bank’s inflation target of 4%, emphasizing that it was not within the 2-6% tolerance band.
This may have dashed the rate-cut hopes of several brokerages and clarity may emerge only in the next policy meeting in December.
Food inflation currently poses the Monetary Policy Committee’s most significant challenge. However, if inflation does not align with the MPC’s target, can the committee contemplate a rate cut? Governor Das’ recent comments on the policy stance suggest this is unlikely. “The question of neutrality will arise only when you see inflation at around 4% on a durable basis,” he noted. “When we are convinced that it has come below 4%, and it is likely to be sustained at that level, then that would be the ground for a rethink.”
This indicates that the MPC is unlikely to reduce rates while maintaining the current policy stance. With inflation not expected to durably align with 4% even in the next financial year, the possibility of a rate cut seems remote. This may disappoint bond market participants and economists who, until recently, expected a rate cut as early as April.
Inflation has not consistently stayed close to 4% for the past four years. Since October 2019, headline inflation remained below 5% in just nine months. This financial year, it averaged 5.6% up to August. Before that, from August 2016 to October 2019, when the 4% inflation target was adopted, CPI inflation averaged 3.6%. The primary driver of sub-4% inflation during that period was ultra-low food inflation, averaging 1.8%.
Moving target
The question that remains is when this target will be achieved on a sustained basis, rather than the specified target itself.
The RBI’s Monetary Policy report suggests that headline inflation is projected to average 4.5% in 2024-25 (Apr-Mar), with a range of 3.8-5.2% for the year. It also indicates inflation at 4.0% in July-September the following year.
While these projections indicate that 4% inflation is expected in the next financial year, it’s unlikely to persist durably. Economists’ consensus estimates forecast inflation to be around 5% in the upcoming financial year, contradicting the RBI’s projections.
Moreover, several factors pose upside risks to the RBI’s estimate for 2024-25, including food inflation, crude oil prices, and El Niño. Food inflation remains a persistent concern, with ongoing price pressures in cereals, pulses, spices, and sugar. Additionally, there are apprehensions that low water reservoir levels might impact this year’s rabi (winter) crop, potentially affecting food inflation beyond the current financial year.
