Rapid-fire inflation control by central banks in the post-Covid period is mostly complete. Major central banks like the US Fed, Bank of England, European Central Bank, and Bank of Canada have already cut their policy rates.
The central banks in emerging economies such as China, Indonesia, South Africa, and the Philippines have followed Western countries. The US Fed seems to have abandoned the goal of achieving an inflation target on an enduring basis.
A possible reason could be geopolitical risks disrupting the supply chain — a supply-side phenomenon over which central banks have the least control, preventing inflation from reaching the last mile to the target. Most central banks are moving towards the policy convergence.
Inflation control is an overriding objective of monetary policy, particularly in inflation-targeting countries. Aggressive monetary policy in the post-Covid period has tamed retail inflation in most countries. At the same time, real GDP growth seems to have been adversely affected mainly due to high real interest rates in many countries. Barring Japan, the real interest rates in several countries are significantly positive (see the table).
The IMF’s October 2024 World Economic Outlook (WEO) has maintained the world GDP growth at 3.2 per cent in 2024, the same as in the July update. However, growth momentum is weak in many systemically important countries like China, the European Area, West Asia, and Japan.
The latest WEO recognises the downside risks to global growth. Other than high interest costs, geopolitical risks, global debt overhang and inward-looking trade policies would dampen the world growth momentum. While fiscal space is limited in many countries due to the high debt-GDP ratio the burden of public policy may fall on the central banks to stimulate growth.
The equilibrium real interest rate in developed countries, corresponding to their potential output, is typically low, between zero and one per cent compared to 1-2 per cent in emerging market economies, amidst country-specific variations. Major central banks may continue the rate-cutting cycle for some time to reduce real interest rates unless inflation flares up due to demand-supply mismatches.
Indian Scenario
According to the RBI, the average CPI inflation may be 4.5 per cent in FY25 compared to 5.4 per cent in the previous year. India’s retail inflation may broadly align with the target in FY26. The RBI has not explicitly abandoned the argument that CPI inflation should be enduringly secured at 4 per cent.
However, the Monetary Policy Committee changed the monetary policy stance to neutral in October 2024. The rate cut at this stage was perceived as premature or even dangerous.
Barring a few food items/vegetables, retail inflation in India is mostly under control. Core CPI inflation remained below 4 per cent since December 23. Even headline inflation would have been at least 50 basis points lower than the current reading had there been a change in the base year with a lower weight of ‘food and beverage’ in the CPI basket based on the consumer expenditure survey of 2022-23.
Despite global headwinds, India’s growth outlook is perceived to be resilient. In the October 2024 policy, the RBI maintained the GDP growth projection at 7.2 per cent in FY25 compared to the median growth projection of 6.9 per cent by professional forecasters.
The RBI in its October Bulletin reported India’s nowcasting growth at 6.8 per cent in FY25Q2. In the October 2024 WEO, the IMF maintained India’s growth at 7 per cent in FY25 compared to 6.5-7 per cent projected by the government in the last Economic Survey.
The RBI’s assessment that tight monetary policy has not adversely affected GDP growth is debatable.
Growth pangs
Sequentially, India’s growth momentum has weakened from 8.6 per cent in FY24Q3 to 7.8 per cent in FY24Q4 and further to 6.7 per cent in FY25Q1. According to high-frequency lead indicators, India’s growth may be well below RBI’s projection of 7 per cent in FY25Q2. India’s August industrial production was negative for the first time in the last three years despite the ensuing festival demand.
India’s composite PMIs for September/October 2024 were the lowest since January 2024. Urban demand looks weak due to a slowdown in FMCG/automobile sales besides moderation of capacity utilisation. Credit growth in the first half of FY25 was much lower than that in the H1FY24. It is difficult to ignore these trends as temporary.
India’s CPI inflation of 5.5 per cent in September 2024 is a one-off increase due to the base effect. Taking the average inflation rate as 4.5 per cent, India’s real policy rate (repo rate minus average inflation rate) would be around 2 per cent in FY25. Notwithstanding sound macroeconomic fundamentals, India’s private investment has not picked up significantly due to high interest costs.
The only silver lining has been sufficient liquidity in the banking system since July 2024 (except briefly in September due to advanced tax payment) leading to the weighted average call money rate — the operating target of monetary policy — prevailing below the repo rate since early October 2024.
Is this a de facto rate cut in October 2024? Or, is RBI preparing the financial market for a repo rate cut in December 2024?
The writer is currently the RBI Chair Professor at Utkal University and former Head of the Monetary Policy Department of RBI. Views expressed are personal