August 2024 RBI MPC minutes says, Inflation above all else

23 Aug 2024 , 09:17 AM

WHAT THE AUGUST RBI POLICY STATEMENT FOCUSED ON

On August 22, 2024, the RBI published the Monetary Policy Committee (MPC) minutes. In India, the norm is to publish the minutes exactly 2 weeks after the policy announcement. The minutes published by the RBI on August 22, 2024 once again underscored the intent of the RBI to be cautious about food inflation. When the policy statement was announced on August 08, 2024, the RBI maintained status quo on rates and underlined concerns over inflation. However, there were two voices of dissent for the second policy in a row. Ashima Goyal and Jayanth Varma objected to the status quo on rates and voted for a 25 bps cut in the repo rates. At the same time, Goyal and Varma also wanted a change in the stance of the monetary policy from “withdrawal of accommodation” to “Neutral.” However, the August 2024 policy marked the end of the tenure for Ashima Goyal and for Jayanth Varma and both these members will not be part of the MPC from the October policy onwards.

The August 2024 monetary policy marked the ninth consecutive policy when the rates were not touched. It has now remained at 6.5% since February 2023. There has been an increasing clamour for the RBI to start cutting rates and there are several reasons for this view. The current repo rate is still a full 135 bps above the pre-COVID rate of interest, despite growth having long crossed the pre-COVID levels. Secondly, the real rates of interest in India are today at around 2%, which is nearly 100 bps above the average real rates that we have seen in India. Thirdly, there are concerns that the higher level of reop rates is starting to impact the cost of funds for Indian corporates and that was evident in the Q1 results. Overall, the RBI MPC decision was to maintain status quo on rates and also in the stance of the policy. In addition, when the RBI MPC presented the policy, they also maintained the GDP growth estimate for FY25 at 7.2%, while the inflation estimate for FY25 was also maintained at 4.5%. There may be a legitimate case for RBI to think of rate cuts.

WHAT CHANGED BETWEEN AUGUST 2024 POLICY AND THE MINUTES

The August monetary policy statement was presented on August 08, 2024 and the minutes have been published on August 22, 2024. In this intervening fortnight, we have seen some very interesting data points crop. Here are 5 data points that have had an impact in the last 15 days since the monetary policy statement was presented by the RBI.

• The US inflation came in 10 bps lower at 2.9% for July 2024, although the PCE inflation is still awaited. The Fed maintained status quo in its last policy, but the minutes published by the Fed on August 21, 2024 almost hint at a highly likely rate cut of 25 bps in the upcoming September meet; although the CME Fedwatch is a lot more optimistic.
• The Q1FY25 results season was almost completed by the middle of August. The one thing that stood out was that while the operating margins of Indian companies had gone up, the net profits had fallen by 4%. That can be largely attributed to higher interest costs showing that higher interest rates were putting a lot of stress on bottom lines.
• Indian consumer inflation came in sharply lower at 3.54% for July 2024. This was led by a sharp fall in food inflation in the month. However, one needs to take this data with a pinch of salt. This comes on the back of an inordinately high base in July 2023, when the inflation rate had crossed 7% due to drought. Inflation may move higher from here.
• The IIP or the index of industrial production for June fell sharply to just over 4%. This could be partially due to election related slowdown, but this slowdown comes on a much lower base. So, it looks like the problem of growth is real and that may make a strong case for the RBI to cut rates in the near future to give a boost to growth.
• Merchandise trade deficit for July 2024 widened sharply to $23.5 Billion, sharply higher than the Jun 2024 figure. While exports growth slowed due to supply chain constraints, the imports have become more expensive due to higher freight and insurance costs. With the CAD likely to edge between 1.8%-2% of GDP, we could see pressure on INR.

It is in this background that the RBI published the minutes of the RBI August 2024 meeting. We now turn to what the 6 members of the RBI MPC debated on with the summary of their observations and inferences from the macroeconomic data flows.

• SHASHANK BHIDE SAYS, INFLATION THE PRIORITY

“The overall macroeconomic outlook is one of fairly strong growth and moderating inflation trend. The setting for monetary policy is, however, marked by the risks to the projected patterns of both inflation and growth. In both the cases, risks faced are common: those associated with the monsoon and climate conditions, external demand.”

According to Shashank Bhide, the Indian monetary priorities are currently in a state of flux. Growth is facing headwinds from domestic cost of funds and external factors; but given a choice, inflation should take priority. He feels there are too many contingent factors at this juncture and status quo may be the best strategy, rather than getting into a situation where reversal may be a tough option. Shashank Bhide voted for status quo on rates and keeping stance as “Gradual withdrawal of Accommodation.”

• ASHIMA GOYAL SAYS, TIME TO TAKE GROWTH SERIOUSLY

“Any emerging market (EM) is subject to many shocks, so it is better if forward guidance on rates is data-based, communicating only the reaction function. Even so, lags in action imply it  is necessary to be forward-looking and take decisions based on expected future variables.”

Goyal has pointed out that there are already some signs of stress on growth. For instance, the Q1FY25 results were lower than expected, with most of the pressure coming as a direct impact of higher cost of funds. Goyal also questioned the traditional wisdom that governments drive growth and not the central banks. For instance, the government has always relied on the RBI to loosen the money strings to boost growth as was evident in the aftermath of the global financial crisis and again post-COVID. The stress is also evident from a sharp fall in consumer confidence as shown by the RBI forward looking surveys.

According to Goyal, Indian growth may be resistant, but the time is not right to rest on laurels because current growth is way below potential. Cutting rates by 25 bps would make a huge difference to the real rates of interest and also to consumer confidence. Goyal cautions that if the real rate continuously deviates from the equilibrium rate, it could make growth volatile, as it did in the previous decade. Goyal pointed that in the last few budgets, fiscal policy had played its part without forsaking on the fiscal deficit ratio. However, it was not the time for monetary policy to do its part. Goyal was a dissenting voice voting for a 25 bps rate cut and change in stance to Neutral. However, this was her last policy as MPC member and she will not be part of the deliberations in the October 2024 MPC.

• JAYANT VARMA STILL CALLS IT GROWTH SACRIFICE

“A confluence of demographic and economic factors have presented India with a rare and a golden opportunity to accelerate its growth over the next decade and beyond. It is one of the tasks of monetary policy to ensure that this opportunity is not squandered by excessively high real interest rates.”

The other dissenting voice in the MPC, other than Ashima Goyal, was Jayanth Varma. In the last few meetings, Varma has pointed to the risk of growth sacrifice, underlining that higher than normal rates were pushing the Indian economy to grow much slower than its potential. He suggests benchmark India’s growth with the potential that the Indian economy has, rather than gloating over how India is the fastest growing large economy in the world.

Varma feels that the MPC members were too sanguine about growth in the coming quarters and there could be disappointments. If private capex has to pick up in a big way (a pre-condition for aggressive growth), then interest rates have to stabilize at much lower levels. Jayanth Varma also gave a dissent note and proposed cutting the repo rates by 25 basis points and shifting the stance of the monetary policy from “gradual withdrawal of accommodation” to a neutral stance. This is also Jayanth Varma’s last MPC.

• RAJIV RANJAN REFERS TO RISING GLOBAL RISKS

“Developments on the global front add to the uncertainty as the outlook is evolving rapidly amidst geopolitical tensions and data releases leading to changing perceptions about global economic prospects adding to financial market volatility. Some countries have embarked on easing cycle as their growth is withering and headline inflation has started softening.”

According to Rajiv Ranjan, there were several X-factors at this juncture; both at the domestic and the global level. However, he remains positive on growth resilience for several reasons. Firstly, the revival in rural consumption was likely to drive a lot of additional consumption growth in the coming months. Secondly, after a weak farm output in 2023, the year 2024 has seen normal monsoons. That means, the contribution of agriculture to the GDP should be more significant this year, compared to 2023. Ranjan also believes that fiscal prudence in recent budgets would also be growth accretive for Indian economy.

In addition, Ranjan also expects the growth to be sustained by higher investment activity as well as capacity utilization as evidenced in the recent bi-monthly RBI forward looking survey. According to Rajiv Ranjan, the real challenge would be inflation. Apart from the food inflation trigger locally, oil remains volatile due to conditions in West Asia. In addition, the rupee has been consistently weakening closer to ₹84/$, and that opens up the risk of imported inflation. While disinflation is expected in the coming months, Ranaj believes that the focus for now should be on inflation control, especially considering that the latest RBI survey had showed signs of a clear rise in inflation expectations. Rajiv Ranjan voted for status quo on repo rates and the monetary stance.

• MICHAEL PATRA SAYS, TIME TO ALIGN INFLATION

“Persistently rising prices are always and everywhere a reflection of too much demand chasing too less supply even if it is a supply shortfall that started the price spiral. It is the remit of monetary policy to adjust demand conditions to the state of supply because this accumulation of price pressures threatens the outlook for both; inflation and growth.”

According to Patra, the ideal situation would have been for food inflation and headline inflation to align; which was not happening. Specific food categories like cereals, pulses, vegetables, and high protein foods were increasing the divergence between food inflation and headline inflation. Incidentally, this higher food inflation is also manifesting itself as higher inflation expectations. However, according to Patra, the RBI is still a long away from aligning the median inflation with the target of 4% on a sustainable basis. The July reading of 3.54% inflation was more the exception due to high base effect. Patra also voted for status quo on rates and the stance of monetary policy.

• RBI GOVERNOR HIGHLIGHTS INFLATION ABOVE ALL ELSE

“Headline inflation in Q2FY25 is expected to be lower due to base effect edge. But, food inflation is not abating, and household inflation expectations have picked up. Monetary policy must be vigilant to potential spillovers of food price pressures to core components. This is critical for last mile of disinflation and anchoring inflation expectations.”

The gist of the governor’s statement was that; high frequency indicators pointed to steady and robust growth in the coming quarters. This was evident from the data points like GST collections, PMI manufacturing, PMI services, core sector growth, e-way bills etc. In addition, with the revival in agricultural output this year, rural demand is also expected to growth; and we are already seeing evidence of that. While Q1FY25 corporate profits may have been under pressure, the growth in OPMs and top line was still robust and higher capacity utilization bodes well for growth.

However, RBI governor has cautioned about being too sanguine on inflation. While the 250 bps of rate hike had managed to moderate inflation, the last mile disinflation was still work in progress. Das is of the view that policy decisions have to be based on hard numbers and tangible evidence rather than on abstract theory. Food inflation was still adding to the headline inflation volatility. Hence, drawing linkages between real rates and net profits and using it to justify a rate cut could actually be misleading from a policy perspective.

To sum up, the majority of the members of the Monetary Policy Committee (MPC) continue to be primarily focused on current inflation and inflation expectations; and both are work in progress. Ashima Goyal and Jayanth Varma have raised concerns about current policy sacrificing growth; and that is entirely a possibility. As the RBI governor best summed up in his concluding observations, “The strong and steady growth impulses are allowing the RBI to focus purely on the sustained descent of inflation to equilibrium levels. The best contribution that monetary policy can make at this juncture is to maintain price stability.” Clearly, when it comes to rate cuts, the RBI governor wants to chart an Indian pathway.