Rate cuts unlikely as RBI trains guns on inflation

In its monetary policy statement on 10 August, the Reserve Bank of India (RBI) is likely to remind us yet again that the war on inflation is not over. Why? A couple of days after the policy announcement, the official consumer inflation data for July will be released. If most forecasters are right, it is likely to print well above the RBI’s upper tolerance limit of 6%. Besides, there is the associated risk of an upward shift in the future inflation trajectory.

Even if the data is not released, one presumes that RBI would have an estimate of the July price-line. If it guides the policy decision, as it should, turning soft on inflation does not seem likely at all.

Elevated inflation will come largely on the back of higher food prices. Uneven rainfall has impacted production vegetables and hampered sowing of rice and pulses. Sowing shortfall could compromise output going forward, leading to future shortages and price pressure.

Besides, global food markets are tight. The Ukraine crisis has clogged supply lines for sunflower oil, while intense heat in the US has affected its soya bean crop. While vegetable price spikes are transitory and could dissipate going forward, cereals or pulses tend to be relatively sticky.

RBI might have little direct control over food prices but it needs to fret over the uptick. Food remains a key component of household baskets and any rise in prices tends to spill over to other categories. How does this happen?

Workers negotiate higher wages to minimize the dent on real incomes as food prices rise. Producers of consumer goods, facing higher wage costs, try to protect operating margins by hiking prices. This could transmit to the prices of their inputs.

To cut a long story short, if food prices remain high for too long, there is risk of a broad-based and persistent rise in inflation. Food prices are also known to have a major impact on inflation expectations that is known to abet future price increases.

That said, RBI is not exactly at ground zero. The impact of a 250 basis point increase in its policy rate over a 10-month period is yet to be entirely felt on the prices, as monetary action tends to work with long lags. Besides, RBI has kept liquidity in the market tight. Core inflation, shorn of fuel and food, has been easing. Both should rein in inflationary impulses even with a food price “shock”.

The rate-setting Monetary Policy Committee (MPC) can stay on hold on 10 August, and reiterate its commitment to hike rates if the inflation data so demands.

Rate cuts, alas, will perhaps have to wait until the second quarter of 2024. Hopefully, by then, inflation would be headed toward 4%, RBI’s medium-term target.

However, RBI is unlikely to act alone. It wants to keep the rupee stable against the dollar (this helps to manage imported inflation) and that, to a degree, entails moving in lockstep with the US Fed.

Mercifully, US inflation seems to be coming under control as its economy cools. Thus, the prospect of a first half 2024 rate cut by the Fed is on the table, and RBI could perhaps take a cue from its American counterpart.

Abheek Barua is an economist with HDFC Bank.

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Updated: 07 Aug 2023, 10:34 PM IST

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