RBI treads with caution with concerns of high food inflation

RBI Governor Shaktikanta Das Image: Elizabeth Frantz / Reuters

The Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) delivered a status-quo policy outcome for the sixth straight time. Remember, it raised the repo rate by 25 basis points from 6.25 percent in February 2023. Since then, the rate-setting panel has unanimously voted to retain the benchmark rate at 6.5 percent and five of its six members voted for a continuation of the policy stance of withdrawal of accommodation. But there was a twist this time.

In the February 8 meeting, the decision to retain the repo rate at 6.5 percent was not unanimous. One of the members, Jayanth Varma, voted for a 25 basis points cut in the repo rate and a clear shift in policy stance from ‘withdrawal of accommodation’ to ‘neutral’. Interestingly, last February, external MPC members, Varma and Ashima, had voted against the 25 basis points rate hike.

On Thursday, the RBI held the repo rate at 6.5 percent and said it will continue to focus on the withdrawal of accommodation as the war against inflation continues in face of possible supply shocks and global volatility.

The RBI, much like other central banks, such as the US Federal Reserve, has kept rates on hold, is closely monitoring inflation, and aims to pin it to 4 percent on a durable basis. Although the US Federal Reserve signalled a pivot in December with the possibility of early rate cuts in the current calendar year, in its own admission, the fight against inflation is not over, and it held rates in its January meeting. 

Also read: We do not wait for the house to catch fire and then act: RBI Governor Shaktikanta Das

Inflation: A Concern

RBI Governor Shaktikanta Das is particularly concerned about high food inflation: “Going forward, the inflation trajectory would be shaped by the evolving food inflation outlook. Rabi sowing has surpassed last year’s level. The usual seasonal correction in vegetable prices is continuing, though unevenly. Yet considerable uncertainty prevails on the food price outlook from the possibility of adverse weather events.”

The RBI projected inflation at 5 percent in Q4FY24 and Q1FY25. This is 0.2 percent lower than its December estimate. In FY25, it continues to see inflation at 4 percent, 4.6 percent and 4.7 percent in Q2, Q3 and Q4 respectively. It pegged its inflation outlook for FY24 and FY25 at 5.4 percent and 4.5 percent respectively.

GDP Growth

The central bank is upbeat about India’s growth trajectory. It expects rural demand to continue to ‘gather pace’ and urban consumption to remain ‘strong’ even as the ‘investment cycle is gaining steam’.

“Agricultural activity is holding up well despite lower rainfall, lower reservoir levels and delayed sowing. Industrial activity is gaining steam on the back of improving performance of manufacturing. The early results of corporates in the manufacturing sector remain upbeat, driven by higher profit margins,” Das noted in his post-conference address.

GDP growth for FY25 is seen at 7 percent with Q1 at 7.2 percent, Q2 at 6.8 percent, Q3 at 7 percent, and Q4 at 6.9 percent with risks evenly balanced.

Liquidity: A Nimble Approach

After a gap of four-and-a-half years, system level liquidity turned into deficit from September. To be clear, liquidity management is outside the ambit of the MPC framework which is focussed on nailing inflation level at 4 percent with a margin of 2 percent on either side of the band. Governor Das said the RBI will deploy a mix of instruments to modulate both frictional and durable liquidity to ensure that money market interest rates evolve in an orderly manner and financial stability is maintained.

“So far as liquidity conditions are concerned, these are being driven by exogenous factors, which are likely to correct in the foreseeable future, aided by our market operations. On our part, the Reserve Bank remains nimble and flexible in its liquidity management through two-way main and fine-tuning operations, in both repo and reverse repo,” Das added. “Financial market segments have adjusted to the evolving liquidity conditions in varying degrees. While the short-term rates have fluctuated, long-term rates have remained relatively stable, reflecting better anchoring of inflation expectations as indicated in the softening of term spread in the G-sec market.”

Lakshmi Iyer, CEO-investment and strategy, Kotak Alternate Asset Managers, expects the liquidity lifeline from the RBI to the banking system to continue.

“Q4 tends to be tight due to advance tax outflows, as also the impending general elections, which could also see currency in circulation going up,” Iyer says. “We expect bond yields to trade in a tight range tracking US bond yield. Foreign buying of govt bonds is likely to keep buoyancy in bond yields intact, despite near-term upticks if any.”

Murthy Nagarajan, head-fixed income, Tata Asset Management, says the mood on Mint Street is a bit subdued after the bi-monthly monetary policy was unveiled. 

“The debt market has reacted slightly negatively due to no statement of easing liquidity, but the long-term positive lies in their commitment to bring CPI inflation to 4 percent level. We should see 10-year yields going down to 7 percent in the coming days as monthly CPI inflation cools down below 5 percent in the following months,” Nagarajan says.

Gurvinder Singh Wasan, senior fund manager and credit analyst-debt, JM Financial Asset Management, believes for now, fixed income markets will follow a ‘buy-on-dip’ mindset reacting to demand-supply dynamics, liquidity, foreign flows and global developments.

Also read: As India grows richer, we have to think about the best way to grow rich: Raghuram Rajan

Policy Outlook

The central bank reiterated its commitment to keep inflation low on a durable basis and remain agile to respond to incoming data. From the commentary of past several meetings, it is clear that the RBI wants to see inflation at 4 percent, and not between 4 percent and 6 percent, before it softens rates and begins the rate-cut cycle.

“The current setting of monetary policy is moving in the right direction with growth holding firm and inflation trending down to the target. Therefore, much has been achieved, but we must remain vigilant. Policymaking during uncertain times has to be based on a continuous assessment of the incoming data and its implications for the evolving outlook,” Das said.

He adds, “Price and financial stability are the foundations for strong, sustainable and inclusive growth. Our endeavour all along has been to take a holistic approach to keep the economy in balance. We must not only preserve the hard-earned strength and stability of the Indian economy but also build on this further for a long haul of higher growth with price and financial stability.”

Stability of the financial system

Aside from the credit policy announcements, Governor Das put the spotlight on the importance of stability of financial institutions.

“Good governance, robust risk management, sound compliance culture and protection of customers’ interest are of paramount importance for the safety and stability of the financial system and individual institutions. The RBI lays great emphasis on these aspects. We expect all regulated entities to accord the highest priority to these functions,” Das said.

On January 31, the RBI issued a strongly worded order to restrain Paytm Payments Bank, a leading fintech company, from accepting fresh deposits or credit transactions (except cashbacks or refunds) from customers after February 29.

The central bank issued guidelines to review the regulatory framework for electronic trading platforms, hedging of gold price risk in the OTC market in the International Financial Services Centre, a principle-based framework for authentication of digital payment transactions, among others.