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Palpable comfort amid Goldilocks scenario

The December MPC meeting minutes reflect RBI comfort on the macro environment, on account of the benign global environment amid a domestic Goldilocks scenario. The need for policy to stay restrictive was emphasized owing to projected inflation being higher than the target, also amplified by frequent food-price shocks. But the risk of ‘overtightening’ was also visible for a few members. The better-thanexpected growth in FY24 drew divergent responses, with Dr. Patra in particular cautioning against demand-pull inflation ahead, while other members remarked that a structural improvement in growth would not be inflationary. Going ahead, fluid global dynamics are likely to play a major role in the RBI’s reaction function. We maintain the RBI will not precede the Fed in any policy reversal in CY24.

Policy position comfortable, but members to stay vigilant

The December MPC meeting minutes reflect a sense of comfort, owing to the benign global environment, moderating core inflation, and robust domestic growth. Nevertheless, various MPC members stressed the need to stay vigilant due to the projected inflation trajectory staying above the inflation target of 4%.

Higher projected inflation backs a pause, but overtightening a risk to watch

Barring Prof. Varma, all MPC members emphasized the need for the policy to stay restrictive as projected inflation (until Q3FY25) remains above 4%. The frequency of food price shocks causing headline inflation to shoot up was also mentioned as a key risk, with Dr. Patra specifically stating that the policy should stay restrictive till such spikes can be seen off without the danger of second-order effects. On the other hand, Prof. Varma opined that the projected inflation trajectory implied a real policy rate of more than 2%, which is much higher than needed. He suggested the real policy rate be brought down to ~1.5% in coming months, as confidence on the downward inflation trajectory rises. Dr. Goyal also mentioned the risk of overtightening if inflation approaches 4% by mid-2024, while the repo rate remains unchanged. Nevertheless, the MPC recognized the persistent decline in core inflation as evidence that policy actions so far are working, and expect this to continue as the impact of policy actions plays out further and input costs log softer growth. Liquidity management did not seem to be as large a concern as in the previous meeting, with tighter domestic liquidity in December. This supports our view that the mention of OMO sales back then was merely a way to depict implied policy bias for higher rates and offer higher risk premia to the world as well as to anchor the INR amid a volatile & unfavorable global macro backdrop.

Healthy GDP growth draws divergent responses

The better-than-expected GDP growth figures for FY24 so far drew some divergent responses from the MPC. Dr. Ranjan stated that the higher growth momentum, taken together with improved capital formation and total factor productivity, may reflect a sustainable improvement in the potential output level of the economy. This structural change could explain the robust growth along with the falling core inflation. Dr. Goyal concurs with this view, opining that real GDP growth of 7% does not necessarily mean that the potential output level has been reached, if reforms raise growth on a structural basis. Such an outcome would not put pressure on core inflation via excess demand. However, Dr. Patra believes that higher growth so far increases the likelihood of demand-pull factors influencing inflation more in coming months, which will further amplify any supply shocks. He therefore cited the need for the policy function to assign a higher weight to inflation than growth, looking ahead.

Policy reversal to be a function of global dynamics

The minutes reflect the RBI’s growing comfort on the current macro environment, despite some caution on the inflation trajectory ahead. We see FY24E inflation at 5.4% (RBI: 5.4%). As the market debates a shift in the timing and quantum of rate-cuts ahead, we maintain fluid global dynamics will play a major role in the RBI’s reaction function. We also uphold that the RBI will not precede the Fed in any policy reversal in CY24, but policy management will have to stay vigilant and policy tools will need to evolve, from conventional to unconventional ones

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