GDP growth likely bottomed out; inflation to prevent December RBI rate cut

The recently released data points on growth and inflation have infused a fresh round of interest in the upcoming Monetary Policy Committee (MPC) meeting that is scheduled to be held later this week. The sharper-than-expected deceleration in the Q2 GDP growth, on the heels of the higher-than-expected October 2024 CPI print is likely to put the MPC members in a tough spot.

 

The Q2-FY25 GDP data, which was released by the National Statistical Office (NSO) last week, was surprising to say the least, with the year-on-year (YoY) growth decelerating to a seven-quarter low of 5.4 per cent in Q2 FY2025 from 6.7 per cent in Q1.  

 

While this was much lower than market expectations, which were around the 6.5 per cent mark, it also significantly trailed the MPC’s estimate of 7.0 per cent for the quarter. Such a large undershooting would force a substantial downward revision in the Committee’s FY2025 GDP growth projection, which had been pegged at 7.2 per cent in the October 2024 meeting.

 

This would also prompt the MPC to relook at their GDP growth estimates for H2 FY2025, which were projected at 7.4 per cent. Such a sharp rebound in growth now seems implausible, notwithstanding the favourable base that would support the GVA growth prints in Q3 and Q4 FY2025 and expectations of a relatively normal GDP-GVA growth wedge compared to the unusual levels seen in H2 FY2024.

 

We remain relatively constructive around the outlook for H2-FY25, amid expectations of an improvement in rural demand owing to the robust growth in kharif foodgrain output and upbeat outlook for rabi crops, a back-ended pick up in the Government of India’s (GoI) capex, and the dissipation of the transient impact of heavy rains which had impacted mining, electricity, construction and retail footfalls in Q2 FY2025. 

 

Nevertheless, the weakness in urban demand and merchandise exports is likely to persist, with sustained high food inflation and slowing consumer loan growth impacting the former, and the sluggishness in global growth continuing to constrain the latter. 

 

Overall, ICRA believes that the GDP growth likely bottomed out in Q2, and is expected to pick up in H2-FY25. However, led by the lower-than-expected print for the just-concluded quarter, we have cut our FY2025 growth forecast sharply by 50 bps to 6.5 per cent from 7.0 per cent earlier. 

 

Inflation trends

 

On the inflation front, the recent trends are equally unpalatable. The headline CPI inflation print for October 2024, which was released in mid-November, hardened to a 14-month high of 6.2 per cent from 5.5 per cent in September 2024, breaching the upper limit of the MPC’s medium term target range of 2-6 per cent after a gap of 13 months. Food inflation soared to double digits in the month, with vegetables inflation printing at a 57-month high of 42.2 per cent.

 

The daily data on retail prices of food items for November 2024 is somewhat benign, suggesting that food inflation is likely to have cooled off somewhat in the month relative to October 2024. Given this, ICRA estimates the headline inflation print to ease to around 5.5 per cent in November 2024, before inching down further to around 5 per cent in December 2024. The CPI inflation for Q3 FY2025 is expected to overshoot the MPC’s estimate of 4.8 per cent for the quarter by at least 60-70 bps. This would warrant an upward revision to its FY2025 CPI inflation projection of 4.5 per cent by ~20 bps to 4.7 per cent.

 

A sharp downward revision in GDP growth projections and an upward revision in the CPI estimates would complicate the MPC’s policy choices. Should it assign a higher weight to the growth outcomes vis-à-vis inflation and immediately cut rates to support the former? Or should it wait until inflation prints recede to more comfortable levels, while entailing a growth sacrifice by keeping rates unchanged? 

 

The sizeable lags in the transmission of monetary policy actions would support the choice of an immediate rate cut. Additionally, the benign outlook for food inflation would lend credence to the same. Nevertheless, we believe that the under the flexible inflation targeting framework, the MPC should not cut rates with headline inflation above the upper threshold of 6 per cent. 

 

By the February 2025 policy review, the Committee would have some clarity on the Rabi crop and its implications for food prices. Vegetables inflation is prone to supply disruptions and climate events, and the extent of the cooling in the same would be key to assess the trajectory of food and headline inflation. Besides, sustained high food inflation has played a significant role in constraining the budgets of low- and middle-income households. Bringing this under control would automatically lend support to the growth in consumption demand and GDP beyond the immediate period.

 

Finally, on the reignited debate around the nominal anchor for the monetary policy, under the inflation targeting framework initially set for a five-year period (2016-21) and renewed by the Government for another five years (2021-26), the MPC has to consider headline CPI inflation for policymaking. 

 

The new CPI series is also due in early 2026, at which point, the anchor could be relooked at based on the revised basket and weights of the constituents. There could be a case for excluding vegetable prices, given the high volatility in the same, and the material difference in the CPI inflation and the CPI inflation excluding vegetables. However, households are unlikely to ignore vegetable prices, while forming their inflationary expectations. 

 

Aditi Nayar is the Chief Economist, Head- Research & Outreach at ICRA. Views are her own.