The latest inflation numbers indicate that the Monetary Policy Committee (MPC) will definitely not consider a rate cut in the upcoming monetary policy in December. The inflation number at 6.2% was not expected, and the relentless high food inflation numbers in the last few months are indicative of something which requires deeper analysis. The core inflation component has also been inching up, though still lower than the 4% mark. What is one to make of these three issues?
In the last policy in October, the Reserve Bank of India (RBI) had changed the stance to neutral while it kept the repo rate unchanged. Should it reconsider the stance given the inflation proclivities? This is an interesting issue that comes up because a change in stance was meant to indicate a possible cut in the repo rate in the future. It does seem that these price pressures will remain for another month and be above 5% in November. This being the case, it can be argued that it may have been premature to change the stance in October. Add to this Donald Trump coming to power, and the case for imported inflation seeping in increases.
Based on Trump’s beliefs expressed during campaigns, tariffs are likely on all imports which will be inflationary. Tax cuts will push up deficits, which will again mean higher borrowing and inflation. The Fed may have to reconsider its downward glide path. With imports under pressure, China will also push for stimulus that will not just elevate commodity prices directly but also force other countries, including India, to reconsider tariffs on such imports. While this scenario can be extreme, one has to wait and watch as this has potential to increase imported inflation.
Therefore, with future inflation likely to have an upside bias, it is not surprising that there is an opinion of exploring the change in stance back to withdrawal of accommodation. This also means that a rate cut in December is out for certain, and, by extension, could also not be a certainty in February 2025. This is notwithstanding the fact that the inflation numbers could be more acceptable then because the RBI has to consider the course of the rabi crop as well as the impact of US policies. Therefore, it is quite possible that the rate cut eagerly awaited by businesses will be seen in FY26 rather than Q4FY25.
Food inflation is a conundrum. In successive years, India has been able to record new peaks in production of various crops. Yet, there are sharp food price shocks. It betrays some interesting points. High wheat production, for instance, does not ensure that prices come down because of the minimum support price, which is increased every season. This means that the threshold prices increase in the market, even when the crop is good, as there is a buyer in the form of the Food Corporation of India which fixes the benchmark. Any production shock only exacerbates the price increase.
Second, outside crops, the issue of vegetable inflation is now a regular feature. The tomato and onion shocks are routine post-monsoon. With changing weather patterns, there is a case of delayed withdrawal of monsoon, which, in turn, affects the harvests. As there is a gap of two-three months before the next crop arrives, inflation is the result. There is also the cobweb phenomenon where farmers sow more of a vegetable when prices rise, only to experience high output and a sharp fall in prices subsequently. Policymakers need to look at the issue anew and think of commercialising such cultivation and linking the same to the food processing industry.
The last factor is vegetable oil prices, which feed into inflation of other associated products such as processed foods as well as services that deal with food products, making it difficult to untangle. With higher demand from China as well as the developed countries (which goes with higher growth), prices have moved up. The strong dollar has added to imported cost, thus pushing up oil inflation. With India importing over 60% of its edible oils, it is but natural that the impact is sharp on food inflation.
Advocates of a rate cut have always pointed to core inflation which has been low, and is what can be influenced by policy. However, this inflation number has been crawling up and is now 3.7%. This is so because manufacturers in particular have been slow to pass on higher input costs due to generalised inflation, which has kept demand compressed. There is evidence to show that companies have been raising their prices of late to maintain profit margins. This has caused core inflation products to witness higher inflation. Therefore, this number will tend to move upwards.
Putting all these developments together, it does appear that the MPC will have to deliberate harder this time on the future course of inflation. The high statistical base effects have not quite played out positively on food inflation. A big relief comfort is that growth appears to be on a stable path of upwards of 7% this year and hence, there would be no haste to lower rates. Besides, the repo rate has averaged 6-6.5% in the last 12 years or so, and therefore there is room to pause further and take a deep breath.
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