In my view. Rate cut: An eye on the MPC’s vote

With hours left for the counting of votes to usher in the next government at the Centre, another important event is lined up for the week: the bimonthly monetary policy statement, set for release on June 7. With the election results and government formation dominating headlines, the decision of the monetary policy committee (MPC) may likely be overshadowed. 

The MPC has kept policy rates unchanged during FY2023-24, and we expect it to remain on ‘pause’ mode at the upcoming meeting too. The RBI has now turned its focus to managing the ‘last mile of disinflation’, as evident from its communication. Retail inflation has moderated to 4.8 per cent in April, from 5.7 per cent in 2023, but it is still above the RBI’s targeted 4 per cent. Elevated food inflation, at about 8 per cent, is proving to be a spanner in the works. The RBI has previously raised concern over high food prices weighing on the inflation outlook, for the spillover risks it poses to headline inflation. At the same time, the decline in energy prices and core inflation (headline minus food and fuel) at a decadal low are providing an offset. 

Amid these push-and-pull factors, we think the RBI may opt for a ‘wait-and-watch’ mode, as it tracks the movement of the monsoon, as also international commodity prices, before it pivots to easing the monetary policy.

Robust domestic show

The biggest factor supporting the central bank’s ‘active disinflationary’ stance is the robust domestic growth conditions. GDP growth at near 8 per cent for FY2023-24 and continuing growth momentum signal that the RBI may see no urgent need to cut interest rates to support growth, at least for now. With incipient signs of an upturn in the private capex cycle as well as rural consumption, the RBI is likely to sound confident on growth outlook for FY2024-25. 

While domestic economic conditions support a hold in June, the outlook for monetary policy is complicated by the re-emergence of a ‘higher for longer’ narrative in the global monetary cycle: With the slower pace of disinflation in the US, markets now expect the Fed to begin monetary easing late in H2 2024, with the likelihood of the first Fed cut extending into 2025. 

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For emerging markets, easing monetary policy while Fed funds’ rate remains high could lead to widening of interest rate differentials, impacting capital flows and straining currencies. Hence, for central banks in many emerging markets, monetary policy reaction includes the Fed outlook. 

However, the RBI stands out in this regard, namely its policy decisions are based largely on domestic growth and inflation, even as it does keep an eye on global developments. Our research shows that every rate hike by the RBI since 2010 has been determined by inflation spikes (barring the Taper Tantrum period). 

Rate cuts, historically, have been in response to growth slowing below trend, provided price pressures are under control. Thus, the RBI accords primacy to inflation (bolstered by its legislative mandate since 2016) and has typically been independent of the Fed. 

Cause for pause

In the post-pandemic period, the RBI’s policy synchronisation with the Fed’s monetary cycle was driven both by domestic conditions and heightened global policy uncertainty. 

So, what does a likely prolonged pause by the Fed mean for the RBI? We think the window for monetary policy easing by the RBI opens only in December 2024. This will be driven more by domestic considerations, as inflation begins to gradually align with the RBI’s targeted 4 per cent in H2 FY24-25 (notwithstanding the moderation due to base effect in Q2). This assumes a normal monsoon and commodity prices that remain well-behaved. 

The RBI could potentially cut before the Fed does. The buffers from the buildup of forex reserves, manageable external financing requirements, and the prospect of sizeable capital inflows from the inclusion of Indian government bonds in global bond indexes have eased the RBI’s worry over pressure on the rupee. 

(The writers are regional economists at Barclays)