The economic backdrop for the upcoming monetary policy is not very encouraging both in terms of global and domestic economic factors. The global growth outlook continues to disappoint. In July 2023, the S&P Global’s gauge of manufacturing activity stayed at a contraction level of 48.7, with sub-indices of factory output and new orders both slipping to six-month lows. While the US and Canada showed stabilisation of manufacturing activity, it contracted for the Euro zone, Japan and South Korea. Even China’s July private PMI (purchasing managers’ index) marked its first fall since April 2023.

The picture is mixed on the global monetary policy front. Central banks of advanced nations raised interest rates in the last round despite cooling inflation. The US Federal Reserve and the European Central Bank hiked rates by 25 basis points (bps) last week and left open the option of further hikes conditional upon the inflation trajectory.

Bank of England raised its key policy rate on August 3 to a 15-year peak and gave a hawkish warning. Bank of Japan — a dovish outlier — too has opened the debate on plans to bring its ultra loose policies to an end soon to control inflation. On the contrary, as inflationary pressures have started easing in most of the Latin America’s major economies, the central banks of Chile and Brazil have initiated a rate-reduction cycle. The central bank of Mexico has signalled an extended pause.

Coming to India, there is certainly a positive side to India’s non-agricultural economic outlook, as seen in the latest prints of manufacturing and services PMIs, direct and indirect tax collections, elevated core (infrastructure) industrial production growth, and a pick up in the passenger and commercial vehicle sales in recent months.

Areas of concern

But concerns too exist in terms of sustained negative or low positive growth in consumer durables’ production (proxy for urban demand) for the past 20 months, high urban unemployment rate (8.06 per cent in July) and weaker private capex cycle due to uncertain demand outlook in the economy.

Agricultural prospects have certainly darkened this year due to highly uneven monsoon rainfall and weaker water reservoir status for major paddy and pulses growing States like Uttar Pradesh, Bihar, Karnataka, Andhra Pradesh, West Bengal, Odisha, Tamil Nadu, etc. Overall kharif sowing is lagging significantly behind the previous year’s level in major agrarian States. Besides, the probability of lower rice and pulses output during FY24 and damage to horticulture and standing crops due to floods remain a possibility in areas that are experiencing heavy rainfall.

Thanks to the previous year’s rich rabi harvest and improved non-farm income levels, farmers’ cash-flows have remained decent so far. But going ahead, likely losses in kharif output will have some adverse impact on both farm incomes as well as food inflation. Unevenness in the spread of rainfall and kharif sowing will lead to differential farm prospects in different States and Union Territories.

While the usual monsoon seasonality has raised the prices of vegetables and eggs, a strong upside bias is seen in the prices of wheat, rice, pulses and spices. There is a strong possibility that the Monetary Policy Committee of the RBI will revise upwards its inflation projections for FY24 by factoring in these supply shocks.

The MPC may also revise downwards its GDP forecast of 6.5 per cent, considering an adverse weather shock and contracting exports.

Given the “unevenness in growth” and the fact that CPI inflation is still anchored close to its tolerance limit, the MPC may hold policy rates at their current level in the upcoming meeting. As “core liquidity” remains in rich surplus, the policy stance will be retained at “withdrawal of accommodation.”

However, the RBI’s forward guidance will be more “hawkish” to prepare markets for a longer pause. India’s rich foreign exchange reserves at $607 billion and an import cover of more than 10 months would enable the RBI to extend the “pause” even when the top central banks continue to extend their rate-hiking cycle.

The writer is Group Chief Economist, L&T Finance