RBI’s Blind Spots

RBI’s decision comes in light of recent inflation data, particularly concerning food prices, which has raised concerns about inflation exceeding the RBI’s target. However, there are broader economic considerations influencing this decision beyond just inflation.

Inflation Dynamics

• Current Inflation Status: The consumer price index (CPI) inflation reached a 14-month high of 6.21% in October, primarily driven by food prices, particularly vegetables.
  • Excluding vegetables, the headline inflation was significantly lower at 3.3% in September and 3.6% in October, indicating minimal underlying price pressures.
• Food Price Influence: The RBI has expressed concerns about high food inflation potentially spilling over into core inflation through a wage-price spiral.
  • However, this concern may be overstated as labour markets remain weak, with muted wage growth and low bargaining power for workers.
  • The central bank anticipates that food prices will stabilise as new harvests come in, particularly with a promising outlook for the rabi crop.

Economic Growth Considerations

• Growth Forecasts: Despite rising inflation, the RBI has maintained its GDP growth forecast at 7.2% for the fiscal year 2024-25.
  • However, there are signs of slowing momentum in various economic indicators, which contradicts the RBI’s optimistic outlook.
• Government Pressure: There is increasing pressure from the government for the RBI to consider cutting interest rates to support economic growth.

External Influences

• Impact of US Economic Developments:
  • Since September, the US Fed has reduced short-term interest rates by 75 basis points, but long-term rates have still increased.
  • Under a second Trump presidency, expectations of higher tariffs, which will be inflationary, and tax cuts, which will increase deficits, have pushed the 10 year-US treasury yield to 4.44 per cent, up from 3.61 per cent a few months ago.
• Foreign Investor Pullout:
  • Foreign investors withdrew $14 billion from Indian stock markets over the past two months, adding pressure on the rupee.
  • Despite efforts, the RBI has struggled to stabilise the currency.
• Rate Cut Risks:
  • Lowering interest rates could trigger further capital outflows, weakening the rupee.
  • A weaker rupee, while beneficial for exports, would adversely impact major corporate groups with significant foreign currency debt.

Conclusion

While inflation remains a critical concern for the RBI as it approaches its December meeting, various other factors—including weak labour markets, government pressure for rate cuts, and external economic influences—are likely to play a significant role in shaping its decision-making process. The central bank’s leadership may need to navigate these complexities carefully before determining its course of action regarding interest rates and currency management.

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