MPC Meet: Why RBI is unlikely to change stance or interest rates

With monetary policy a tossup between growth and inflation, the recent economic good news (8.4 percent GDP growth in Q32024) would have enthused RBI to be upbeat about growth. It has in fact upped its nowcast GDP growth for Q4-2023-24 to 7.2 percent and 7.4 percent for 2024-25 and even other international agencies are revising their estimates upwards. But inflation stubbornly remains above the RBI’s target of 4 percent rate. Headline inflation has been at 5.1 percent in February 2024 while core inflation eased down to 3.4 percent, but food inflation worryingly rose to 7.8 percent in February from 7.6 percent earlier.

With adverse heat conditions predicted, agriculture output and food prices can be problematic and therefore it is unlikely the RBI is going to reduce policy rates any time soon, especially if it feels the growth concern is out of the way. But it will also be aware that besides monetary policy, it took a host of other measures such as cuts in excise duty on petrol and diesel, reduction in import duties on key raw materials and crude edible oils to moderate inflation. The most recent ones include reduction of petrol, diesel and LPG prices which will also surely work through the system.

Highs and Lows of GDP Growth

The fact that GDP growth was led by manufacturing (on the supply side) and investment on the expenditure side, may suggest, in hindsight, that high cost of capital did not matter. But on the flip side, the low growth in personal consumption, GDP’s largest driver, has been a huge cause of concern. Here again, it is believed to be coming mainly from rural distress and high inflation which may not relate directly to high interest rates. Nevertheless, the calls to boost consumption spending will invariably have to come through rate cuts. But the cost of credit narrative itself seems a little shaky here. For one, overall credit still grew by 13 percent till Jan 2024 (excluding the HDFC merger effect) which, though lower compared to previous year, seemed to belie the notion of higher interest rates dampening credit demand (a 250 bp hike in the previous year). In fact, credit card debt and unsecured personal consumption loans have continued to record high growth in spite of the RBI’s regulatory clampdown and increased cost of credit. Second, credit demand by industry was tepid, growing only at 7.8 percent (infrastructure credit even lower at 6 percent). This was not due to high lending rates but due to sluggish investment demand. Low credit offtake is especially puzzling when viewed against the high PMI numbers and strong manufacturing performance in GDP.

What to Expect?

With this being the first meeting of a new financial year and with elections around the corner, neither rate nor stance changes are likely. If there is any indication of a change in stance to neutral from the present tight policy, it could also be an indication of rate cuts down the line but that would again depend on a bunch of unknowns- weather, rainfall, the US Fed policy actions and possibly even the outcome of the elections, making it hard to predict. The comfort of sustainable GDP growth itself rests on a few fragile assumptions which can change and upset the estimates such as if manufacturing’s stellar show in Q3 turns out to be a flash in the pan, if trade deficits go out of control due to a surge in oil prices or a decline in exports, or if personal consumption continues to flag.

Interest rate policy will also be watched keenly by another segment viz. bank depositors. The year saw banks scrambling for deposits due to tight liquidity and also slowing CASA deposits. The intense competition for longer term deposits has led to deposit rates hitting all-time highs, with rates also being constantly revised upwards as banks competed amongst themselves.  This has already impacted net interest margins of banks, but depositors are enjoying the benefits of positive real rates after a long time. With gross financial savings of households having fallen steeply to 5.1 percent of GDP in fiscal 2023, from 7.2 percent previously, this is another perspective that the RBI may want to be watchful about.

SA Raghu is a columnist who writes on economics, banking and finance. Views are personal and do not represent the stand of this publication.