February 2024 RBI MPC minutes still cautious on inflation

26 Mar 2024 , 03:16 PM

Policy backdrop to the February 2024 minutes

As is the normal practice, the RBI announced the MPC minutes a full 14 days after the RBI monetary policy statement. It may be recollected that when the RBI had announced the monetary policy on February 08, 2023, and so the minutes have now been published on February 22, 2024. The February, the last RBI MPC meeting of FY24, held repo rates static at 6.50%, the sixth consecutive policy when the status quo on rates were maintained. The Q2 growth for the quarter ending September came in at 7.6%, much better than expected. However, the December GDP growth number and the cumulative 9-month GDP data will only be out on the last day of February. Interestingly, on the last day of February, the MOSPI will also be releasing the second advance estimate of full year GDP for FY24.

While the rates were left untouched in the February policy, there were some positive trends on the macro projections. It may be recollected that in the December policy, the RBI had maintained its inflation forecast for FY24 at 5.4%, but raised its GDP forecast for FY24 by 50 bps to 7.00%. In the February MPC meeting, the RBI estimates did not tinker with the FY24 projections of inflation and GDP growth. However, it reiterated that FY25 GDP growth would mark the third year of 7.0% plus accretion in output. In addition, the inflation forecast for FY25 has been pegged at 4.5%, which is nearly 90 bps lower than the current estimate of 5.4% for FY24. This is an indication that GDP had held steady to robust and inflation was firmly under control and moving towards the targeted 4% mark.

Is there a case for the RBI to cut rates now?

The big question in the last few months has been, whether the time is ripe for the RBI to cut rates and, if so, when should the RBI start cutting rates? For starters, the RBI is unlikely to take any decision on rate cuts till the new government is in place and the full budget has been presented somewhere in July 2024. But there is certainly a strong case for the RBI to cut rates, and here are 3 reasons for the same.

• The repo rate just before the rate cuts started before the COVID pandemic was 5.15%. To ease liquidity during COVID, the RBI aggressively cut rates, down to 4%. Between May 2022 and February 2023, the RBI hiked rates by a full 250 basis points to 6.50%. At the current juncture, there is a case to bring the rates back to 5.15%, the pre-COVID level.

   

• The decision to cut rates is largely driven by the real rate of interest i.e., the gap between the 10-year benchmark bond yields and the average rate of inflation. Currently, that real rate gap is around 225 bps to 250 bps, and that surely makes a case for the RBI to cut rates from current levels.

   

• The Fed has already guided for 175 bps of rate cuts or more by the end of 2025. While it may have decided to back-end rate hikes, the Fed is surely on target to cut rates. Even the Fed is unlikely to cut rates before June, so the timing would be right for the RBI as it coincides with the full budget and also the rising need to cut cost of borrowings.

It is in this background that the RBI published the minutes of the RBI February 2024 meeting. Here is what the six members of the RBI MPC spoke about as well as the specific areas they focused on.

1. Shashank Bhide speaks on the Goldilocks effect

“Moderation in consumer inflation and lower commodity prices in the international markets are positive impacting input costs for domestic manufacturers. In addition, the increased pace of government capex spending has offset the impact of adverse growth conditions. Broader high frequency indicators like non-food credit, PMI and GST flows are buoyant.” Shashank Bhide underlined the fact that the Indian economy was into something of a Goldilocks effect. 

Inflation had fallen faster than expected and the GDP growth was coming in higher than expected. This had created an effect, wherein the real growth was getting a boost and was persistently surprising on the upside. Bhide voted for a status quo on the repo rates and also to remain focused on withdrawal of accommodation. According to Bhide, Even after the latest fall in inflation, the target was still more than 110 bps away. Hence, caution was surely warranted on the inflation front.

2. Ashima Goyal feels corporate look and feel is still good

“Inflation has come in below predictions and core inflation continues to soften, indicating that output remains below capacity. Reforms and structural changes are reducing costs. Profit margins have risen although corporates are preferring volume over price growth. Corporate results show real sales growth continued to outpace nominal growth in Q3. Faster than expected fiscal consolidation and a continuing better composition of government expenditure, will also lower inflationary pressures.”

Goyal has focused on two aspects of the macros at the economy level. Firstly, corporates find themselves in a sweet spot with sales growing and the costs falling sharply. This has allowed most of the Indian companies to grow sales and profits despite the weakness in rural sales. At a macro level, some of the structural cost reductions are happening due to better connectivity, sharper use of digital technology and emerging platforms like artificial intelligence and machine learning. 

While Goyal has hinted towards a rate cut in the future, the view is that currently the RBI can afford to keep rates higher considering the robust growth numbers. India has avoided the risk of hard landing, despite aggressive rate hikes as government led capex has made the big difference. Ashima Goyal voted to keep the rates static at 6.50% and the stance of the monetary policy as “gradual withdrawal of accommodation”

3. Jayant Varma continues to play the devil’s advocate

“Inflation is projected to average 4.5% in FY25, and, so, the policy rate of 6.5% translates into a real rate of 2%. Such a high real rate is not required at this stage to drive inflation down to the target of 4%. Economic growth is holding up well, but there is no evidence at all that the economy is overheating. In a nutshell, the growth pessimism is warranted.”

Interestingly, Jayant Varma was the only member of the MPC to vote for a cut in rates by 25 bps from 6.50% to 6.25% as a starting point. He also had a difference of opinion as “gradual withdrawal of accommodation.” According to Varma, the problem is that, at a time when the liquidity situation was already undersupplied in the financial markets, such a stance did not add any practical value. According to Varma, it is essential to keep the real rate of interest around the 1.5% mark, which would be more like an optimal level. 

In the past few policies, Varma had voted to keep policy rates constant and had skipped the vote on the monetary stance. However, he feels that the time is ripe for changes at both levels. According to Varma, a rate cut of 25 bps will bring the real rates closer to 1.5% and that would be the right level to balance growth and inflation. He feels the time is also ripe to shift the chances to neutral, considering the current liquidity conditions in the market.

4. Rajiv Ranjan prefers to maintain the current stance

“Markets are running ahead of policy makers worldwide; including India. Any change in policy direction is going to have a multiplier effect. This is tricky considering transmission has slowed down in the last two months. The weighted average lending rate on fresh loans from commercial bank has fallen by 18 bps. Changes at this stage could be a misstep.”

According to Ranjan, the RBI had frontloaded a lot of the rate cuts even it meant to err on the side of caution. The good news is that inflation did come down but growth was not really impacted as India continues to be the fastest growing large economy in the world for two years in a row. At over 7% growth in GDP projected for FY25, India is likely to continue as the fastest growing large4 economy for the third year in a row.

According to Ranjan, the monetary policy in the current context must continue to treat a cautious and prudent path. Ranjan not only voted to keep the rates static at 6.5%, but also to maintain the monetary stance as withdrawal of accommodation. Ranjan has underlined that rate cuts and the transmission to the final customer was still work in progress. However, the core point here is that the RBI has to manage the descent of inflation also successfully and that means calibrating any plans to cut rates.

5. Michael Patra wants inflation to align with target

“The optimism generated by evolving macroeconomic conditions and recent improvement in financial conditions in response to a friendly budget would get an added boost only if inflation eases and aligns with the target. The outlook for Indian economy is still sensitive to inflation risks. More so, since high inflation normally hits the most vulnerable sections.”

Michael Patra admits, that there is a shift in the undertone of the Indian economy from consumption to capital expenditure. It is not just consumption that is driving the economy but the massive capex program triggered by the Indian government. After growing capex allocation by 33% in the last 2 years, the latest Union Budget has raised capex by another 11.1%, which is very impressive on a higher base. While it would need lower cost of funds to fructify over time, the time may still not be ripe.

Patra voted to maintain repo rates at 6.5% and to maintain the stance of the monetary policy as “gradual withdrawal of accommodation.” According to Patra, for the rates to start easing, only when the inflation rate starts easing and aligns with the target on a sustainable basis. Dr Patra also feels that while there may be a case for rate cuts at a fundamental level, the practical problem is that move towards target inflation was still not visible. Hence wait and watch, would still be the buzzword for now.

6. RBI Governor cautions against premature rate cuts in India

“The current setting of monetary policy is moving in the right direction, with growth holding firm and inflation trending lower. Currently, monetary policy must remain vigilant and not assume that the job is done. We must remain committed to successfully navigating the “last mile” of disinflation which can be sticky. As markets are front-running central banks in anticipation of policy pivots, premature moves may undermine the inflation gains.”

The RBI governor has underlined that the policymakers cannot afford to be sanguine about inflation, just because it has shown a downward trend. India inflation is up against two challenges. Food prices are awfully cyclical in India and that remains a major swing factor for inflation. That has already been visible in the year 2023. The second factor is the emerging contours of the Red Sea crisis. The situation is such that the route shifts have the potential to cause imported inflation through the sharp spike in freight and insurance costs. Hence, caution on the inflation is warranted.

Parting thoughts on the RBI MPC February 2024 minutes

The gist of the MPC minutes is that, the RBI is unlikely to be in a hurry to cut rates or turn dovish. Status quo on rates and the policy stance may continue. For now, inflation will remain the primary concern and the best the RBI will do is to create enabling conditions for GDP growth. However, GDP is growing at its own momentum in India. As the RBI governor has reiterated int the past, it is the last mile that is often the most difficult path to traverse. It is not just the rate of inflation, but also the inflation expectations that have to be brought down. For that we have to await the next monetary policy to be announced by the RBI in early April, although it is the June 2024 policy that could set the tone for rate cuts.