A long pause

Central bank communication will be crucial

After a few difficult years, the central bank’s monetary policy committee (MPC), which is meeting this week, will find itself in a comfortable position. Economic growth has been better than expected with a decline in the inflation rate. The numbers released by the National Statistical Office last week showed the Indian economy expanded 7.2 per cent in 2022-23, as against the official projection of 7 per cent. It would also be comforting for the MPC that higher than expected economic growth, according to economists, may not push up the inflation rate because it is being driven largely by investment. The inflation rate based on the consumer price index ebbed to 4.7 per cent in April and is expected to remain relatively soft in the coming months. Global commodity prices have cooled and input cost pressures have moderated. The Bloomberg Commodity Index, for instance, has declined about 15 per cent over the past year. The core inflation rate too is showing signs of moderation.

It thus remains to be seen if the MPC revises its inflation projection in this meeting or waits for some time. One big risk to inflation outcomes this year would be the El Nino effect and its implications for the monsoon. Although the India Meteorological Department expects a normal monsoon, a significant shortfall or uneven distribution could put pressure on food prices. Meanwhile, Saudi Arabia decided on Sunday to cut crude oil production by 1 million barrels per day starting July, while other members of Opec+ extended the production cut till the end of 2024. A lower supply, leading to higher prices, would affect inflation outcomes. Given the overall macroeconomic conditions, the MPC is widely expected to leave the policy rate unchanged and see how the situation unfolds in the coming weeks and months.

However, communication by the central bank will be important this time. The Reserve Bank of India (RBI) will need to make it clear to financial markets that another pause should not be interpreted as increasing the possibility of a rate cut in the coming months. The central bank will need to keep the policy rate at this level and see how it works through the system. In this context, it would also be important to leave the stance unchanged. It is worth noting that the inflation rate is still above the target of 4 per cent and the RBI will need to ensure that it comes closer to the target on a durable basis. The average inflation rate in 2022-23 was 6.7 per cent. Further, global conditions remain somewhat uncertain. Although the headline inflation rate in the US, for example, has moderated, the core hasn’t. Financial markets are thus not ruling out another rate hike by the Federal Reserve.

Given the tightening of global financial conditions, it is important that the central bank doesn’t lower its guard prematurely. In the bond market, yields on both five- and 10-year bonds have declined by about 30 basis points since the beginning of the year. Liquidity conditions have eased, partly because of the return of Rs 2,000 notes into the banking system. The flow of foreign portfolio investment has also improved. Overall, while macroeconomic conditions look comparatively good, sustaining growth in a relatively unsupportive global environment would be challenging. Besides, consumption demand remains weak, which can affect medium-term prospects. The RBI, however, cannot do much in this context. It will have to be addressed from New Delhi.