Number Theory: Why RBI is not likely to cut policy rates on Friday

The Monetary Policy Committee (MPC) of the Reserve Bank of India will begin its three-day bimonthly meeting today.

This is the last MPC meeting before the presentation of the Union budget – likely a Vote on Account this time – on February 1, 2024. The decisions of the MPC meeting will be announced on Friday. While there are a lot of technicalities to framing of monetary policy, the most keenly watched decision of MPC is on interest rates. The committee has increased the rpolicy rate by 250 basis points – one basis point is one hundredth of a percentage point – between May 2022 and February 2023, leading to a significant increase in debt servicing and mortgage costs for firms and households. Most analysts are of the view that MPC is unlikely to change rates in its meeting. Here are four charts which explain their reasoning.

The decisions of the Monetary Policy Committee meeting will be announced on Friday. (MINT)

Why RBI is not likely to cut policy rates on Friday

• 
  Headline and core inflation is falling but food prices remain volatile

  India’s benchmark inflation rate, as measured by the Consumer Price Index (CPI), has fallen from 7.4% in July 2023 to just 4.9% in October. CPI core – it excludes the food and fuel component of the CPI basket and is considered to be less prone to seasonal shocks – was at 4.3% in October 2023, which is the lowest it has been since March 2020. Core inflation has either stayed constant or fallen every month since January 2023. These numbers would suggest that inflation is not much of a problem for the Indian economy. However, a look at food inflation – food has a share of 39% in the CPI basket – shows that not only is food inflation still above the 6% mark, the recent spike in headline CPI was almost entirely on account of an increase in food inflation. With the El Nino weather phenomenon, and the consequent uncertainty about the prospects of the winter crop, still in play, experts say RBI is unlikely to drop its guard on inflation despite a benign core inflation environment.
• 
  Growth continues to remain strong

  RBI’s inflation targeting mandate does not work in isolation, and is envisaged as a balancing mechanism between inflation and growth. This is where the September quarter GDP numbers released last week come in. At 7.6%, GDP growth was significantly higher than analyst estimates, and unless RBI drastically cuts its December and March quarter inflation forecasts, it is also a given that MPC will make an upward revision to its October projection of 6.5% GDP growth for 2023-24. At a time when headline inflation continues to depend on the volatility of food prices and growth is doing better than expected, RBI is highly unlikely to pivot to a pro-growth stance from an anti-inflation one.
• 
  Even consumer sentiment is not falling

  To be sure, the headline GDP growth numbers do not tell us the entire story of the economy. A disaggregated analysis of the GDP numbers shows that government spending, especially in investment, is the key driver of growth momentum while private consumption continues to be weak. A continued weakness in private consumption numbers suggests that a large part of the population is not a stakeholder in the overall economic dynamism in the economy. When read with the fact that a lot of households would have faced a squeeze on their budgets because of increase in mortgage payments due to the 250 basis point hike in the current rate hike cycle, it makes sense to argue that a rate cut would have helped restore consumer sentiment in the economy. Data from RBI’s Consumer Confidence Surveys show a complicated picture on this front. While overall consumer sentiment continues to remain negative, its trajectory has been one of improvement rather than deterioration during the period when RBI has implemented its rate hikes – perhaps because the overall economic situation has improved in this period.
• Most experts agree that RBI is unlikely to reduce interest rates in this MPC meeting. “We expect the repo rate to be on hold at 6.5%, and liquidity to remain tight with the call money rate trending higher than the repo rate. We also expect the stance to remain an unchanged ‘withdrawal of accommodation’ given liquidity remains tight. RBI may focus more on tweaking macro prudential norms, to address some excesses in the system. It has already raised risk weights on certain lending”, HSBC chief India economist Pranjul Bhandari said in a note dated December 5.