14

Oct

Prices Rise Stops RBI From Changing Interest Rates

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Prof Shivaji Sarkar

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New Delhi | Monday | 14 October 2024

A forward-looking Reserve Bank of India (RBI), anticipating a rise in prices, has opted not to alter interest rates. It's not only food prices that have seen an uptick; many commodity prices overall have surged beyond 5% in September, as per the Consumer Price Index (CPI). With the onset of the festival season, costs have further increased, putting pressure on households.

The RBI's decision, following the Monetary Policy Committee (MPC) meeting held on October 7-8, reflects a cautious approach by Governor Shaktikanta Das. He remains wary of inflation exceeding 4%, as it can push the economy into an uncertain zone. This is visible in the recent dip in industrial production, a weakened rupee, and declining foreign exchange reserves, all of which signal discomfort in the economic environment.

India's CPI-based inflation exceeded 6%—a level considered high by the MPC. Bloomberg estimates suggested that inflation would rise to 5.1% in September, following a 3.65% increase in August and 3.54% in July. The RBI, which targets an inflation range of 4-6%, now faces a situation where inflation consistently hovers above this tolerance limit.

Despite holding off on interest rate hikes for now, the RBI is closely monitoring global factors, including the U.S. election results. Rising U.S. inflation and ongoing geopolitical conflicts in Western Asia and the Russia-Ukraine region have global ramifications. Depending on these outcomes, the December MPC meeting may adopt a different stance.

Article at a Glance

The Reserve Bank of India (RBI) has decided not to alter interest rates, anticipating a rise in prices due to surging commodity prices and the onset of the festival season. The Consumer Price Index (CPI) has exceeded 6%, and the RBI is cautious about inflation exceeding 4%, which could push the economy into an uncertain zone. The RBI is closely monitoring global factors, including the U.S. election results, and may adopt a different stance in the December MPC meeting.

Key Points:
The RBI has opted not to alter interest rates due to rising prices and inflation concerns.
The CPI has exceeded 6%, and the RBI is cautious about inflation exceeding 4%.
The RBI is monitoring global factors, including the U.S. election results, and may adopt a different stance in the December MPC meeting.
Rising crude oil prices, withdrawal of foreign portfolio investors, and escalating tensions between Israel and West Asian countries have exerted downward pressure on the economy.
India's foreign exchange reserves have dropped, and the economic environment is marked by surging prices across various sectors.

Newly-appointed MPC member Nagesh Kumar, with his experience in international organizations, seems more attuned to corporate needs. He has suggested a rate cut, aligning with corporate interests for cheaper credit. However, the RBI cannot directly control global economic conditions or mirror every move by the U.S. Federal Reserve. The recent 50 basis point rate cut by the U.S. Fed was largely influenced by political considerations tied to the U.S. presidential election, where corporate groups lobby for lower credit costs. Indian corporations, too, have been advocating for rate cuts to support their financial interests.

Back in 2009, the RBI had consistently raised interest rates to combat inflation, and the current economic environment could potentially call for similar actions. The stock market remains volatile, consumer demand is subdued, and industrial growth is faltering, reflecting a challenging market scenario.

The Indian rupee has also weakened significantly against the dollar over the past four months, declining from ₹80 to ₹83 in the earlier period and further dropping to ₹84.07. This is contrary to expectations that rate cuts by the U.S. Fed would weaken the dollar and support the rupee. In contrast, other Asian currencies have appreciated by over 5% during the same period. The RBI might allow the rupee to stabilize within the ₹84.2 to ₹84.35 range, with some leeway towards ₹83.7–83.8.

Additionally, rising crude oil prices and the withdrawal of foreign portfolio investors (FPIs) have exerted downward pressure on the economy. With Brent crude increasing from $69 per barrel in September to $78.92 in October, energy costs are on the rise, contributing to further inflation. The escalating tensions between Israel and West Asian countries could push import costs higher, potentially leading to further price hikes around the Diwali season, dampening consumer demand.

India’s foreign exchange reserves have also taken a hit, dropping by $3.709 billion to $701.176 billion for the week ending October 4, according to the RBI. This decline follows a sharp increase in the previous week when reserves reached an all-time high of $704.885 billion.

The economic environment is marked by surging prices across various sectors. Medicine prices, for example, have seen a hidden increase as companies have reduced the quantity of products without changing the price tags. Household essentials like cooking oils, soaps, and detergents have become more expensive, driven by rising input costs, such as palm oil and copra. FMCG companies have reported reduced earnings in the September quarter due to these rising costs, further straining consumer budgets.

Bread and other staples have also become more expensive, creating additional challenges for households trying to manage rising expenses. The recent increase in import duties has contributed to the rise in vegetable oil prices, further squeezing profit margins for companies. While inflation poses a significant risk to businesses, high demand for their products allows them to compensate for projected losses through price increases or by reducing packaging sizes.

The RBI and MPC have warned that unexpected weather events, geopolitical conflicts, and the recent increase in prices of edible oils, wheat, and key vegetables present upward risks to inflation. Prices of vegetables and other food items have remained elevated over the past several weeks, and even tea prices have inched upwards.

With the ongoing Israel-Iran conflict, inflation across all commodities could intensify as the global situation deteriorates. The Indian economy is also grappling with reduced purchasing power due to high unemployment (estimated at 9% in June by CMIE), limited wage increases, a shift towards more casual employment, and a slowdown in industrial output. According to the National Statistical Office (NSO), the Index of Industrial Production (IIP) contracted by 0.1% in August, following a 4.7% rise in July and 10.9% growth in August 2023. The manufacturing sector grew by only 1% compared to 10% in August 2023, while the mining sector rose by 4.3% (down from 12.3% in 2023) and the electricity sector fell by 3.7% (down from 15.3% in August 2023). The core sector, which accounts for 40% of the IIP, contracted by 1.8%.

The latest MPC report has maintained a headline growth rate of 7.2%. However, the persistent price pressures could alter this projection, making it difficult for the economy to maintain its current trajectory. With higher inflation, the country faces the challenge of recalibrating its economic path, particularly as job and wage issues become increasingly pressing. The coming months will test the RBI's strategy and the resilience of the Indian economy in navigating these inflationary pressures while maintaining growth stability.

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