2 months ago
118
Manish Kothari
The Reserve Bank of India (RBI) has stuck to its playbook and has maintained status quo on the key policy rates and retained its stance of withdrawal of accommodation--which is consistent with its stated view of retaining sharp focus in aligning inflation to the target (of 4%) on a durable basis, while balancing economic growth and financial stability. The Governor re-emphasised this sufficiently when he said that only stable and low inflation at 4% will provide the necessary bedrock for sustainable and long-term economic growth.
The Monetary Policy Committee (MPC) maintained its stance and policy rates unchanged, aligning with the stated objective of the government--to curb inflation. A similar thought was articulated by U.S. Federal Reserve Chair Jerome Powell in its recent meeting, at a time when the market was expecting a cut in rates.
Headline inflation, after moderating to 4.9% in October, rose to 5.7% in December 2023. This was primarily due to food inflation, mostly vegetables. RBI has reiterated that its stance of withdrawal of accommodation should be seen in the context of incomplete transmission and inflation which has been above the 4% target.
The softening in core inflation (CPI inflation excluding food and fuel) continued across both goods and services, reflecting the cumulative impact of monetary policy actions as well as significant softening in commodity prices. The uncertainties in food prices, however, continue to impinge on the headline inflation trajectory.
Amidst a globally varied economic landscape, certain factors suggest a potential soft-landing scenario. Inflation is edging closer to the 4% target, and both advanced as well as emerging market economies are exhibiting more resilient growth than initially anticipated.
Robust domestic demand
Domestic economic activity remains strong with real GDP growth at 7.3% for 2023-24, making it a third consecutive year of 7% plus growth. Industrial activity is gaining steam on the back of improving performance of manufacturing. The investment cycle is gathering momentum, supported by continued government capital expenditure, growing capacity utilization, increased flow of resources to the commercial sector, and policy backing from initiatives like the production-linked incentive (PLI) scheme. In this context, the Governor has projected an expected GDP growth of 7% for 2024-25.
When we look at some of the early corporates’ earnings in the manufacturing sector, there seems to be growth driven by higher profit margins. The Purchasing Managers’ Index (PMI) for manufacturing indicates expansion, accompanied by a strengthening future activity index indicating the same. Improved employment conditions and easing inflation, alongside resurgence in agricultural output, are expected to bolster household consumption on the demand side. Rural demand remains on an upward trajectory. Urban consumption remains strong on the back of improved income levels.
The services sector is anticipated to maintain its resilience, supported by robust domestic demand and favourable global prospects. January’s (2024) PMI services recorded a notable increase, indicating sustained robust expansion. Furthermore, the strong demand for residential housing, combined with heightened government capital expenditure, is poised to drive growth in the construction sector.
Liquidity management
While the system level liquidity turned into deficit from Sep’23 (after a long gap of 4.5 years), the potential liquidity in the system (adjusted for government cash balances) is still in surplus. Additionally, government spending picking up over the last few weeks has also led to some augmentation of system-level liquidity. Similarly, while long-term rates have remained relatively stable reflecting better anchoring of inflation expectations, monetary transmission remains incomplete in the credit market. Effectively, the Governor said that they believe that “risks are evenly balanced” and the last mile of disinflation being most challenging. And hence their policy stance should be seen in that context.
When it comes to financial stability, RBI has clearly spelt out that good governance, robust risk management, sound compliance culture and protection of customers’ interest are of paramount importance for the safety and stability of the financial system and individual institutions. This indicates that in addition to the healthy balance sheets of banks and financial institutions, the RBI accords highest priorities to compliance and risk management.
The continuation of rising food prices poses a threat to the current disinflation trend, potentially leading to a destabilization of inflation expectations and widespread price pressures. These risks are compounded by emerging geopolitical tensions and supply chain disruptions. In light of these persistent uncertainties, monetary policy is watchful to guide us through the final stages of disinflation effectively. After all, maintaining stable and low inflation at 4% is essential for fostering sustainable economic growth.
(Manish Kothari is President & Head of Commercial Banking, Kotak Mahindra Bank)
