The Reserve Bank of India (RBI) recently decided to hold interest rates steady, maintaining a hawkish stance, which has sparked discussions about its independence. However, ING's analysis suggests that the decision is more reflective of the current economic environment than a demonstration of autonomy.
An Unexpectedly Intriguing Meeting
On the surface, the latest RBI meeting seemed routine. India’s headline inflation remains at 4.8% year-on-year, within the upper half of the RBI's target range of 2-6%. The first quarter of 2024 saw a robust GDP growth of 7.7% year-on-year. Despite expectations of Federal Reserve rate cuts being distant, and the Indian Rupee (INR) holding steady due to heavy RBI intervention, political dynamics have added a layer of complexity.
The loss of Prime Minister Narendra Modi’s outright majority has necessitated greater reliance on coalition allies. This shift has fueled speculation about increased government spending, potential delays in reforms, and concerns about the RBI's independence. In this context, the RBI's firm stance against immediate rate cuts can be seen as a response to these pressures, indicating no easing until later in the year.
The Case for Easing
Given the strong growth and inflation just below 5%, the call for rate cuts might seem unusual. Yet, two members of the Monetary Policy Committee (MPC) have advocated for it, arguing that current rate policies are stifling growth. They point to the gross value added (GVA) measure of economic output, which has consistently underperformed GDP growth. While GDP for the first quarter of 2024 was at 7.7%, GVA was only 6.3%, raising questions about the reliability of GDP statistics.
Moreover, high unemployment amidst strong GDP growth has fueled voter dissatisfaction. Lower interest rates could potentially stimulate growth, addressing some of these employment concerns.
Core Inflation and Future Outlook
Headline inflation has been high mainly due to elevated food prices, while core inflation appears more stable. However, the RBI notes that non-core inflation influences are likely to persist. The bank anticipates inflation to dip below the mid-point of its target range only briefly in the third quarter of this year. The RBI is cautious, considering the asymmetric risks posed by climate change and meteorological shocks to food prices.
Despite having one of the highest policy rates in the region, the RBI is waiting for more definitive signs of inflation easing towards its target before considering rate cuts. ING forecasts the RBI will hold off on cutting rates until the fourth quarter of this year, though this could happen sooner if the Federal Reserve begins to ease, reducing pressure on the INR.
While the RBI's latest decision reflects caution and current economic conditions, political and global factors will continue to influence its policy direction.
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