With food inflation looming large, ‘shallow rate’ cuts expected only in Q3 FY25

• Food inflation is expected to be elevated due to the heat wave’s impact on cereal and pulse prices.
• Analysts mostly see shallow rate cuts that might come in the third quarter of FY25, as the inflation picture emerges.
• The Indian economy’s Goldilocks moment is continuing and might weigh on GDP growth projections of FY25 at 7%.
  

The ongoing heatwave conditions, and projections of a harsher summer, are likely to impact India’s agricultural output, leading to rising food inflation. This, among others, is expected to weigh heavily on the rate-setting panel or monetary policy committee (MPC) meeting that will start today.

“We estimate food inflation to remain elevated above 7.5% in the first half of 2024 on the back of high cereals and pulses (legumes) inflation on the back of an ongoing heatwave in the country. Altogether, we estimate headline (retail) inflation to remain above 5% in 1H 2024,” says a report by Goldman Sachs.

Core inflation, however, has been easing, and LPG price cuts are also expected to add to the disinflation process, albeit modestly. Most analysts expect inflation to average around 4.5% for FY25 — and cool after a spike in September.

‘Slightly soften hawkish forward guidance’

The Reserve Bank of India (RBI) which intends to maintain retail inflation at around 4%, might go for possible interest rate cuts only in the third quarter of FY25, surmise analysts.

“We believe the stance should continue to be withdrawal of accommodation. RBI might cut rates only in the third quarter of FY25, such rate cut cycle is likely to be shallow,” said a report by SBI Research.

In the meantime, there is ample room for the central bank to hold rates. "We do not expect any change in the policy rate, but a probable explicit or implicit change in stance cannot be ruled out. RBI may acknowledge that core inflation is trending down,” Parijat Agrawal, head – fixed income at Union Mutual Fund, said on the April policy.

Apart from softening core inflation, easing liquidity conditions are also expected to provide comfort to the central bank. Thanks to active interventions by the RBI, government spending over the last month has softened inter-bank rates and short-term borrowing rates for bank and non-bank entities.

“Liquidity conditions have eased in the past few weeks, with ongoing balance of payments surpluses and pre-election spending likely to keep liquidity conditions in check,” says a report by Barclays.

Goldman forecasts one 25 basis-point cut each in Q3 and Q4 of 2024. “We expect the RBI to take comfort from declining core inflation, slightly soften its hawkish forward guidance, but remain cautious given upside risks to food inflation from weather shocks, and repricing of the Fed funds rate easing path,” it added.

Signs of slack in the economy

The central bank ‘upgraded’ its GDP growth rate expectation for FY24 to 7.3%. It also expects FY25’s growth rate to average at 7%. The market is keenly looking forward to RBI’s commentary on growth projections.

As of now, there has been a mixed growth picture. Every economic indicator comes with a rider attached, which Barclays calls ‘signs of slack’ in the economy. For example, the current account deficit (CAD) narrowed to 1.2% of GDP in Q3 FY24, from 1.3% in the previous quarter. While manageable CAD is good news, it also expands during high periods of growth.

The government also projected its fiscal deficit to fall to 5.1% in FY25 as compared to 5.8% in FY24. These targets are to be achieved by moderation in government capex and lowering of expenditure.

“The latter implies limited direct support to consumption demand from the budget, which, while positive for inflation, also means the fiscal impulse on growth has moderated compared with earlier years,” says Barclays.

Economic indicators are also mixed. While cargo traffic, air passenger numbers, and toll collection are falling, vehicle sales are seeing double-digit growth in the last quarter of FY24.

“High-frequency activity data remains strong, with our proprietary indices tracking a rebound in consumption growth at 7.9% yoy in Jan-March of 2024 (vs 3.5% in December quarter), but slower investment growth at 2.3% yoy (vs. 10.6% YoY in December quarter) as the government has front-loaded capex,” says Goldman Sachs.

The Goldilocks moment of the Indian economy is raising expectations that the RBI might take a call based on the same. “Eventually, we think the RBI will have to consider the balance of risks between overtightening (given the 'not-too-hot-nor-too-cold' state of the economy) and maintaining monetary policy conditions for achieving reasonably good real GDP growth of at least 7%,” says Barclays.