RBI treads cautiously on inflation amid monsoon worries

Given the uncertainties around the impact of El-Nino conditions leading to sub-par monsoon in 2023, the Reserve Bank of India seems to have treaded cautiously while revising the inflation projection by only 10bps to 5.1% for FY24. Especially as the monsoon outlook and the impact of El Nino remain uncertain, RBI Governor Shaktikanta Das feels close and continued vigil on the evolving inflation outlook is absolutely necessary.

The forecast of a normal south-west monsoon by the India Meteorological Department augurs well for the kharif crops. Uncertainties, however, remain on the spatial and temporal distribution of monsoon and on the interplay between El Nino and the Indian Ocean Dipole. "Geopolitical tensions; uncertainties around the monsoon and international commodity prices, especially sugar, rice and crude oil; and volatility in global financial markets pose upside risks to inflation,” say experts.

Taking into account these factors and assuming a normal monsoon, CPI inflation is projected at 5.1 per cent for 2023-24, with Q1 at 4.6 per cent, Q2 at 5.2 per cent, Q3 at 5.4 per cent and Q4 at 5.2 per cent, according to the RBI. While the RBI decided to keep the policy rates unchanged for the second consecutive meeting, it has continued to emphasise on bringing the retail inflation closer to the target of 4%.

Das has stressed on moving towards the primary target of 4% inflation. In this backdrop, expectation of rate cut in this calendar year seems to be faded. Amid a volatile global economic scenario and lingering risks to domestic inflation, it is prudent that the RBI has followed a wait-and-watch strategy. "With concerns on the growth front abating and CPI inflation likely to remain above the 4% target, we expect a status quo on the policy rates in 2023," says an economist.

The RBI sees FY24 GDP growing at 6.5% (unchanged), while headline inflation is seen averaging 5.1%, a tad lower than the earlier estimate of 5.2%. Although the inflation outlook has turned favourable (real rates are projected to stay positive), RBI alluded that the inflation level within the tolerance band does not yet warrant a rate cut.

"We believe inflation is on a sustained decline with lag impact of RBI rate hikes and prices of commodities declining drastically. Our reading is that disrupted supply across the world is back on stream and therefore fall in price of coal, natural gas, oil, steel, wheat, lumber, palm oil, milk etc are sustainable. RBI is bound to change stance in time to come," said another expert. Inflation, thus, continued to remain a concern and is expected to remain above targeted levels right through FY2023-24 as per RBI’s forecasts.

Accordingly, despite the pause in rate hikes, the Monetary Policy Committee (MPC) is exercising tight control over monetary conditions by continuing its stance of withdrawal of accommodation. The RBI Governor has pointed out that in H2FY24, the inflation is expected to be higher, averaging at around 5.3%, and a much closer look on the inflation at that point is warranted as by then any negative impact from the El Nino will be clear. Currently, the RBI has assumed a normal monsoon in the inflation projections.

Overall it seems to be an action-oriented policy with evenly balanced approach. However, in view of the dynamic world economic scenario, experts anticipate that RBI will remain watchful. The RBI Governor further said that with the recent rabi harvest remaining largely immune to adverse weather events, the near-term inflation outlook looks more favourable than at the time of the April MPC meeting. The forecast of a normal southwest monsoon by the India Meteorological Department (IMD) augurs well for the kharif crops.

The consumer price inflation eased during March-April 2023 and moved into the tolerance band, declining from 6.7 per cent in 2022-23. Headline inflation, however, is still above the target as per the latest data and is expected to remain so, according to RBI's projections for 2023-24, he said. Therefore, close and continued vigil on the evolving inflation outlook is absolutely necessary, especially as the monsoon outlook and the impact of El Nino remain uncertain, he added.

According to an RBI survey, inflation expectations of households for three months to one year ahead horizon have moderated by 60 to 70 basis points since September 2022. This would indicate that anchoring of expectations is underway and that monetary policy actions are yielding the desired results. "At the same time, given the uncertainties, we need to maintain Arjuna's eye on the evolving inflation scenario. Let me re-emphasise that headline inflation still remains above the target and being within the tolerance band is not enough. Our goal is to achieve the target of 4.0 per cent going forward," Das said.The CPI inflation for May is scheduled to be announced on June 12. The government has mandated the central bank to ensure inflation remains at 4 per cent with a margin of 2 per cent on either side.