4:2 Split In RBI, CPI At 4.75% - A Case For An Early Rate Cut In 2024! But There's More To An Eye That Meets

India's CPI inflation has eased to a 12-month low of 4.75% in May 2024, while core inflation has cooled off to its lowest level which is a major positive factor for warranting a rate cut sooner than expected. Not to forget, the latest inflation print comes at a time when there is a split of 4:2 among MPC members for holding the key repo rate at 6.5%. While the case for early rate cuts heightened, there are still a few factors that are acting as spoilsport and in some expert's opinion is likely to delay the possibility of lowering rates.

India's CPI inflation came in at 4.75% in May 2024, easing for the fifth consecutive month and marking the lowest level in 1 year. Further, inflation is now lower than RBI's upper tolerance limit of 6% for the ninth month straight.

Core inflation which stood at 3.1% year-on-year, is another key positive for a rate cut.

Further, Nikhil Gupta, Chief Economist, MOFSL Group detailed that inflation in core services dropped below 3% for the first time, while about 26% of the CPI basket posted 5%+ inflation last month, the lowest level since Jan-20%. Also, excluding veggies, headline inflation was 3.5% YoY, the same as in the previous two months.

Also, Raghvendra Nath, MD, Ladderup Wealth Management said, "India's CPI has dipped to a 12-month low of 4.75% in May 2024, below the estimated 4.85%. Meanwhile, core inflation has also decreased to 3.1% from April's 3.2%. However, food inflation remains sticky at 8.69%. These figures are likely to reassure the Reserve Bank of India (RBI) regarding the downward trend in inflation, echoing recent discussions at the MPC meeting."

But before the 12-month low inflation print, the early signs of a sooner-than-expected rate cut emerged when among six members of MPC which is including RBI governor Shaktikanta Das, two of them voted for changing the monetary policy stance to 'Neutral' and cut rates in June policy.

According to Elara Capital, it is pertinent to note that dissent within the MPC (Monetary Policy Committee) is growing, as two of the MPC members have now voted for rate cuts as well as for easing the policy stance. This indicates that we are getting closer to the last leg of the rate cycle.

Despite the case of an early rate cut being visible, yet, RBI is likely to not cut rates anytime soon. In some expert's opinion, a rate cut is not warranted even in 2024, but rather in 2025. While believe that the rate cut cycle could start from the October policy and not the August policy.

The reason why the trajectory for when RBI will cut rates is still unclear is because of sticky food inflation which is the biggest elephant in the room currently. RBI stays focused on being disinflationary to achieve a 4% medium-term target despite the consistent drop in CPI. Also, RBI is more

Sujan Hajra, Chief Economist & Executive Director, Anand Rathi Shares and Stock Brokers said, "The retail inflation rate for May 2024 was lower than expected, both in core and non-core components. Despite this, inflation remains significantly above the RBI's target, making a rate cut in the next six months unlikely. The strong GDP growth from last year and the anticipated robust growth for the current year further support this stance. Additionally, the higher-than-expected industrial production in April 2024 reinforces this view."

Also, Gupta said, "Headline inflation could under-shoot the RBI projections in 1HFY25, increasing the pressure to cut rates (or change its stance). We believe, however, that rate cut is likely only in late CY24 or early CY25."

As per Antique Stock Broking, food inflation remains elevated at 8.7% YoY and sequentially increased by ~0.7%. Key categories seeing high inflation are vegetables (27.3% YoY) and pulses (17.1% YoY). Key products seeing a deflationary trend are mustard/ refined oil, masur dal, dhania, and dry chillies; while an inflationary trend continues in categories like rice, chicken, mango, potato, onion, tomato, garlic, arhar, and turmeric.

ICRA estimates the food and beverages inflation to ease somewhat in June 2024 vis-à-vis the May 2024 print, while remaining elevated above the 7.0% mark in the month. This would help contain the headline CPI inflation print at sub-5.0% in June 2024. Thereafter, a favourable base is expected to lead to a sharp albeit temporary fall in the CPI inflation to 2.5-3.5% in July 2024 and August 2024.

Moreover, Aditi Nayar, Chief Economist, Head of Research and Outreach at ICRA said, the Southwest Monsoon has seen an early onset in Kerala (June 1) and Northeast India (June 5) by two and six days, respectively, over the normal onset date. Nevertheless, adequate volume and dispersion of rainfall in the season remain key to improving the prospects for the Kharif crop and replenishing the reservoir levels, which would be crucial to support the rabi crop and rein in food prices.

In Sujan's view, the pressure is likely to mount on RBI to cut rates.

Sujan explained that high real policy rates are dampening private investment. With developed countries and the US expected to start rate cuts in the next three months, the RBI will face increased pressure to adopt a more accommodative policy. Already, two of the six members of the Monetary Policy Committee have shown support for softening the monetary policy. Overall, it will be challenging for the RBI to maintain its current pause and liquidity-tightening stance for a long. The combination of falling inflation and robust growth in India is positive for the equity market.

In the June 2024 policy, RBI said, that looking ahead, overlapping shocks engendered by the rising incidence of adverse climate events impart considerable uncertainty to the food inflation trajectory. Market arrivals of key rabi crops, particularly pulses and vegetables, need to be closely monitored given the recent sharp upturn in prices. Normal monsoons, however, could lead to softening of food inflation pressures over the year.

RBI further added that pressure from input costs has started to edge up and early results from enterprises surveyed by the Reserve Bank expect selling prices to remain firm. Volatility in crude oil prices and financial markets along with firming up of non-energy commodity prices pose upside risks to inflation.

Hence, RBI keeps the inflation target above its key medium target of 4%. RBI has forecasted CPI inflation for 2024-25 at 4.5 per cent with Q1 at 4.9 per cent; Q2 at 3.8 per cent; Q3 at 4.6 per cent; and Q4 at 4.5 per cent.

Going to the external factor, while Nath expected that inflation at 4.75% and core inflation at the lowest level is a reassurance for RBI that CPI is on the downward path, however, he also believes the early rate cut scenario may be off the table if there's a surprising hawkish shift signalled by the anticipated US CPI release and FOMC statement.

And that has happened! The FOMC gave hawkish outcomes despite US inflation data coming softer than expected. Fed kept key fund rates at a 23-year high of 5.25-5.5% for the seventh time in a row. Instead of earlier three rate cut expectations in 2024, the Fed now expects only 1 rate cut this year and hints at four rate cuts in 2025.

On the Fed policy and US inflation data, Subho Moulik, Founder & CEO, Appreciate said, "The 3.3% CPI reading in May was the kind of positive reading that the Federal Reserve was pinning its hope on after a disappointing first quarter this year. The reading goes on to add more grist to Chair Jerome Powell's belief that inflation is moving gradually towards the 2% target, even if it might be doing so on a somewhat bumpy path. A series of cooler-than-anticipated inflation readings coupled with moderating labour market conditions in the coming months will go on to bolster the Federal Reserve's confidence that its soft landing goal is truly attainable, and within sight."

Moulik also said, "As far as the economic projections are concerned, I would be cautious about putting too much weight on the expectation of just one rate cut this year. "

However, RBI governor Das has already stated that the rate cut expectations from the Fed have moderated in the market. He said, "Some central banks from advanced economies like Switzerland, Sweden, Canada and the Euro Area have begun their rate easing cycle during 2024. On the other hand, market expectations of a rate cut by the US Fed, which was higher earlier, have moderated subsequently."

Hence, it will be keenly watched if RBI also follows the one rate cut pattern, or surprises the street with multiple rate cuts in the second half of 2024 or with no cuts in the current year as long as food prices remain elevated posing a risk to CPI.

Antique in its note said, "We expect RBI to start the rate cut cycle from the October policy (with the policy stance changing to neutral in the August policy) post signs of food inflation easing given the above normal monsoon prediction. Overall, we expect the repo rate to cool off to 5.25%-5.50% (50-75 bps rate cut in FY25 and 25-50 bps in FY26) considering FY26 CPI estimate of ~4.25% and 1.0% neutral rate."