Climate conditions key to keep (inflation) elephant in the forest

In our view, overall, a no-change in policy should be construed as a good signal; displaying policy consistency. The April policy outcome was the seventh successive policy where rates and stances were unchanged.

The last monetary policy rate action was seen in February 2023, when the repo rate was hiked by 25 bps to 6.50%. During this 14-month-long long-pause phase, interestingly, growth projections were slightly sharper upward revisions than inflation projections.

In this period, while the MPC deliberated on policy changes, the () continued to focus on liquidity management, keeping it synchronous to monetary policy’s withdrawal of accommodation stance.

On liquidity management too, the RBI Governor reiterated that the central bank maintained its nimble-footed and flexible approach to managing liquidity conditions to ensure price and financial stability. Thus, a status quo on all fronts.

So, what exactly was the highlight of this policy? Well, it was the ‘elephant’ analogy that got a lot of attention. Even ours, here is why.

The governor in his speech stated, “…the elephant in the room was inflation. The elephant has now gone out for a walk and appears to be returning to the forest. We would like the elephant to return to the forest and remain there on a durable basis.”

Even as headline CPI inflation is seen tapering off to 4.5% YoY from the estimated levels of 5.4% YoY in FY24, the uncertainties around food inflation linger.

After witnessing a 6% deficient rainfall last year, low reservoir levels, especially in the southern states, and the outlook of above-normal temperatures during April-June also pose concern.

Volatile food prices interrupt the path of disinflation and cloud the inflation outlook, keeping the MPC vigilant.

The RBI governor reiterated that the last mile of the disinflation path is always challenging and sticky. The global food price outlook is also subject to significant upside risks from the historically unprecedented heat wave sweeping across the globe.

The India Meteorological Department (IMD) has forecast above-normal temperatures and heatwave days during the summer season. Climate change has increased the frequency and ferocity of weather shocks, posing challenges for monetary policy.

All these developments could impart upside risk to the domestic food inflation trajectory. In numbers, it could raise headline inflation by around 100bps over the baseline (which for FY25 is at 4.5% YoY).

On the other hand, ample foodgrains buffer stocks and effective supply management could help ease food inflationary pressures and pull headline inflation 50 bps below the baseline, as per the RBI report. But, risks are still on the upside.

Thus, until the summer months are behind us and there is clarity on India’s 2024 monsoon season, we think the weather conditions will weigh more in policy making.

The current outlook on weather and from the detailed monetary policy report, we think that the Central Bank would remain vigilant and take a cautious approach to policy actions given that food inflation has averaged 7.4% YoY in FY24 and 6.6% in FY23.

While CPI inflation, excluding food and fuel, referred to as core CPI, is expected
to stay mellow in FY25, a lot hinges on the trajectory of food inflation.

Recurring food price shocks are impeding the ongoing disinflation process. The recent firming up of international crude oil prices warrants close monitoring.

The MPC’s inflation outlook takes crude oil prices to $85/barrel. Thus, amid geopolitical headwinds and poor weather conditions over the last 12 months, with concerns already shown for the next three months, we think the FY25 inflation trajectory remains susceptible to weather-driven food price uncertainties.

Thus, the climate conditions would remain key to keeping (inflation) elephants in the forest.

(The author of the article is an economist at RBL Bank)

(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)