In the recent Monetary Policy Statement issued by the Monetary Policy Committee (MPC) of the Reserve Bank of India, the key policy rates are kept unchanged. The liquidity adjustment facility (LAF) remains unchanged at 6.50 per cent and the standing deposit facility (SDF) rate continues to be 6.25 per cent and the marginal standing facility (MSF) rate and the Bank Rate remain at 6.75 per cent accordingly.
These decisions are in line with the RBI objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of plus minus 2 per cent, while still supporting growth.
Resilience seen in the Global Economy
According to the MPC, the global economy is projected to maintain its steady growth in the year 2024. Inflation is at lower levels favored by higher base effects in leading economies yet it continues to be above targeted thresholds set by their respective central banks largely due to stagnancy in services prices.
Yet as they are getting closer to the targeted levels of inflation, financial markets seem to be responding to changing perceptions on the timing and pace of monetary policy trajectories. This is reflected by huge and sustained rallies in equity markets.
It is interesting that despite the projection of the steady growth expected to continue in the current year, the RBI attributes the surge in gold prices due to demand for safe haven. So, apparently we also need to be cautious of some element of uncertainty present in the global economy.
Strong Momentum seen in Domestic Economy
Due to strong momentum in the domestic demand, the real gross domestic product (GDP) has expanded at 7.6 per cent in 2023-24 as per the second advance estimates (SAE). The Real GDP was reported to have increased by 8.4 per cent in Q3 on account of robust investment activity and a lower drag from net external demand. On the supply side, gross value added grew at 6.9 per cent in 2023-24, largely due to spurt in manufacturing and construction activity.
Now since south-west monsoon is projected to be normal, it is going to give support to agricultural activity as well. Besides, manufacturing enterprises are also expected to maintain growth momentum on account of sustained profitability. Services activity too is likely to grow at its normal levels.
Global risks still pose challenges
According to the Reserve Bank’s consumer survey, discretionary spending by urban households may get a boost with improving income levels and the expected spurt in rural activity and steady urban demand. This is going to strengthen private consumption.
Besides, the fixed investment is also projected to be at high levels supported by improved business optimism, healthy corporate and bank balance sheets, robust government capital expenditure and signs of upturn in the private capex cycle. But certain factors may cause uncertainty in the global economy how so much resilient it may seem today. Some of them are explicitly listed out here as they may pose risks to otherwise well poised Indian economy as well:
- Headwinds from geopolitical tensions,
- Volatility in international financial markets,
- Geo-economic fragmentation,
- Rising Red Sea disruptions, and
- Extreme weather events.
The Risks are evenly balanced
Major factors that are going to give support to Indian economy are as under:
- Softening of headline inflation, which has come to 5.1 per cent during January-February 2024, compared to 5.7 per cent in December, 2023. This is below the upper price band of 6 per cent.
- Fuel prices remained in deflation for the sixth consecutive month in February, 2024.
- CPI core (CPI excluding food and fuel) disinflation was down to 3.4 per cent in February, 2024 and this was one of the lowest in the current CPI series, with both goods and services components registering a fall in inflation.
- Food prices edged up to 7.8 per cent in February 2024. Moreover, the increasing incidence of climate shocks coupled with low reservoir levels particularly in the southern states and possibility of above normal temperatures during April-June, also pose concern. But it is expected that record production of rabi wheat production in 2023-24 and early indications of a normal monsoon during the kharif season will help contain cereal prices. Besides tight demand supply conditions in certain pulses and the prices of key vegetables may be tackled through adequate monitoring.
- The recent firming up of international crude oil prices warrants close monitoring. Yet, fuel price deflation is likely to deepen in the near term following the recent cut in LPG prices.
- After witnessing sustained moderation, cost push pressures faced by firms are showing upward bias. Yet corporates may be able to tackle them with strengthening of consumer demand in both urban and rural markets.
Considering that the risks posed to the Indian economy are evenly balanced, the RBI has projected the real GDP growth for 2024-25 at 7.0 per cent in the financial year 2024-25 with Q1 at 7.1 per cent; Q2 at 6.9 per cent; Q3 at 7.0 per cent; and Q4 at 7.0 per cent asserting that the risks are evenly balanced as per the Chart below:
Since there are balancing factors present in the Indian economy and reasonably seen well poised, the MPC has projected the CPI inflation for 2024-25 at 4.5 per cent (Refer Chart 2).
Rationale for keeping the Policy rates unchanged
The MPC decided to keep the policy repo rate unchanged at 6.50 per cent in its recent meeting held on April 5, 2024. All other policy rates are also kept at the same level at which they stood in the previous monetary policy instance. But the proactive instance of the MPC shall continue till they are able to tame inflation (the so-called elephant) and bring it (send him) back to somewhere around the lower threshold of 4 per cent (back to the forest).
MPC instance may continue while anchoring inflation expectations and ensuring fuller transmission. Since the economy is already in to the growth momentum and the risks are projected to be evenly balanced, the choice seemed clear for the MPC to take a firm stance on priority to be given to achieve the durable price stability in the medium term which would set strong foundations for sustaining a period of high growth in the long run. The MPC also decided to continue its stance on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth. The RBI stance seems to be received favorably by the stock markets.