Interest rate cut can be possible in Q1FY25 but that, too, would be data dependent

The RBI MPC (Monetary Policy Committee) left the repo rate unchanged at 6.5% at its August 10 meeting, in line with street expectations. As a result, the Permanent Deposit Facility (SDF) rate will remain unchanged at 6.25% and the Permanent Deposit Facility (MSF) and Bank Rate at 6.75%. MPC continues its stance of ‘withdrawing from accommodation’ (majority 5 to 1) as liquidity becomes a large surplus while inflation increases. The hawkish pause has been widely anticipated, with inflation taking center stage due to the recent rise in food prices, as evidenced by a sharp rise in RBI’s inflation forecasts.
CPI inflation picked up slightly to 4.8% in June 2023 from 4.3% in May 2023, but remained within the RBI’s tolerable range. This increase was largely due to a sharp increase in food inflation, which rose to 4.6% from 3.3% a month ago. Monsoon conditions and uneven heat caused a spike in vegetable prices in some components. The sharp revision of short-term inflation forecasts (forecasts for Q2FY24/Q3FY24 increase by 100bps/30bps to 6.2%/5.7%) reflects the upside risk emanating from food prices. Although the increase in vegetable prices could pose a risk of CPI increase in the coming months; We believe this increase is more transient in nature and will taper off in the second half of the year, as seen historically. RBI has raised its CPI forecast from 5.1% to 5.4% for 2024. Rain resumes after a delayed start time; from the monsoon shortfall in June, it recorded a surplus of 5% above normal in July. However, recent reports from the IMD predict below normal rainfall (below 94% LPA) ) in August. If the spatial distribution of precipitation remains skewed, this could negatively impact kharif planting and exacerbate food inflation in the coming months. The recent spike in international crude oil prices due to supply cuts from OPEC+ countries could also put pressure on import inflation. While food inflation is a concern, the consolation factor comes from the ease of WPI inflation. WPI deflation coupled with weak global prices for many commodities could provide some stepping stone to rising inflationary pressures with a certain lag. Moreover, controlling core inflation also brings a certain comfort. Core CPI fell to 5.1% on June 23 and remains below the one-year average of 5.8%; reflect the impact of past transmissions on the real economy.
Studies have shown that headline inflation follows the trend of the core CPI, suggesting that inflation dynamics remain under control. But the RBI is concerned about the negative impact on households’ inflation expectations. The MPC statement mentions that these shocks are short-term in nature and can be ignored for a while; unless there are frequent effects of food price shocks that can anchor inflation expectations. As precipitation activity increases, the spatial and temporal distribution of the same and probable El Niño events will remain a controllable key.

India’s economic activity continues to show resilience as evidenced by GST, corporate and income tax recovery. Urban demand remains strong, with domestic air passenger traffic and household credit showing sustained double-digit growth. The recovery of kharif farming and rural incomes, service dynamism and consumer optimism should support household consumption. While investment spending by high-end consumers and the government is quite strong; domestic demand is low and exports remain weak.
The government’s focus on capital spending, increased capacity utilization in manufacturing, adjusted commodity prices and strong credit growth are supporting the growth momentum. The RBI maintains its forecast for real GDP growth at 6.5% for FY24. Weakening global demand, geopolitical tensions and developing El-Nino conditions are key risks to GDP growth in fiscal year 24.
Due to excess liquidity in the system, including the withdrawal of Rs 2000 bills; The RBI has asked scheduled banks to maintain an additional CRR of 10% based on the increase in net debt and term debt (NDTL) between May 19, 2023 and May 28. July 2023 to absorb excess liquidity. Following this announcement, Nifty Bank was in the dark as this announcement had a negative short-term impact on banks.
The impact of this announcement must be assessed individually for each bank; The RBI will review this decision by September 8 or earlier on a systematic liquidity basis before the holiday. India’s 10-year G-sec yield remains in range, with policy decision and commentary generally in line with expectations.
The RBI is expected to closely monitor developments in the inflation outlook and focus on keeping inflation expectations steady at its key 4% target, although the task looks daunting.
We think the central bank seems to care less about growth than the uncertainty surrounding the inflation outlook. With the recent rise in food inflation, interest rate cut expectations have been put on hold. We can expect a rate cut in Q1FY25, but that will depend on the data.