The Monetary Policy Committee (MPC) is set to meet during August 8-10, 2023, with a third pause in a row clearly on the cards.

However, the incremental data since the last policy meeting has been unsettling to say the least, which may infuse additional watchfulness into the commentary than that in the previous meeting. Moreover, we foresee an upward shift in the Committee’s CPI inflation estimates, particularly for Q2 FY2024.

After easing to a 25-month low of 4.3 per cent in May 2023, the CPI inflation print had surged to a higher-than-expected 4.8 per cent in June 2023, amid a less supportive base and the onset of the spike in vegetable prices. Nevertheless, the CPI inflation averaged at 4.6 per cent in Q1 FY2024, in line with the MPC’s projection for that quarter.

Given that the vegetable price shock began towards the end of June 2023, its impact on the headline inflation print for that month was rather limited. However, the print for July 2023 is set to bear the full brunt on this account.

Vegetable price spurt

The average retail price of tomatoes has tripled in July 2023 (till July 24, 2023) as compared to the previous month. Moreover, the average price of green chillies has surged by 71 per cent on a Month-on-Month (MoM) basis, followed by a 33 per cent increase in garlic prices and a 27 per cent rise in brinjal prices. These sequential increases are significantly higher than the typical seasonal uptick that is seen in these items during this period. This is set to push up the food, and consequently the headline inflation print, to unpalatable levels in July 2023. In addition, the hardening in cereals and pulses prices, amid a continued year-on-year (YoY) lag in kharif sowing for the latter, would exert upward pressure on the inflation print. Notwithstanding the measures being taken by the government, we are apprehensive that the headline CPI inflation print will temporarily exceed the 6.0 per cent mark in July 2023.

This implies that an upward revision in the MPC’s Q2 FY2024 CPI inflation estimate of 5.2 per cent is inevitable. Looking ahead, the pace of retreat of vegetable prices from the current levels will be crucial. In addition, the monsoon has been particularly uneven so far. After the bursts of rainfall in early-July 2023, sowing is finally beginning to close in on last year’s levels. However, the onset of an El Nino has infused uncertainty to the near-term inflation outlook, given that a sub-par monsoon rainfall in the second half of the season could affect kharif yields and winter sowing, and thereby food inflation.

Growth outlook

On the growth front, as many as 12 of the 15 non-financial indicators witnessed a deterioration in their YoY growth performance in Q1 FY2024, amid a base normalisation across some indicators, weakening external demand and the impact of excess unseasonal rainfall across the country in the first half of the quarter.

Nevertheless, ICRA expects the GDP growth to rise to 8.5 per cent in Q1 FY2024 from 6.1 per cent in Q4 FY2023, on account of an expected improvement in corporate margins amid the significant YoY deflation in global commodity prices in Q1 FY2024 relative to Q4 FY2023. This is higher than the MPC’s estimate of 8 per cent for that quarter.

Overall, the vegetable price shock, the expected upward revision in the Q2 FY2024 CPI inflation print and the increased uncertainty around the near-term food inflation outlook are likely to manifest into an increased hawkishness in the MPC’s commentary. This would also warrant a continued pause on the policy stance.

Given the transient nature of shocks in food items, particularly in some vegetables, our base case is a status quo on rates through FY2024, with the earliest rate cut foreseen only in the June 2024 policy review.

However, if the CPI inflation appears set to materially overshoot the MPC’s projections for two quarters, led by a generalisation of food price pressures, then a rate hike can’t be ruled out.

The writer is Chief Economist, Head- Research & Outreach, ICRA