Will RBI beat the US Fed in cutting interest rates?

It is believed that the US Federal Reserve will cut interest rates first, and inspired by that move, the Reserve Bank of India will follow suit with its rate cuts of 50-75 basis points. Following the release of the inflation data last week in either of the countries, is it possible that the Reserve Bank of India will breast the rate-cut tape first? The RBI Governor Shaktikanta Das has repeatedly said there is no 1:1 link between US and Indian interest rates and that the Indian central bank follows the local inflation and growth prospects. If he stays true to that sentiment, he might end up taking the lead. Can India see its first rate cut in August after the presentation of the full budget post-elections?

Tale of Two Inflations

Last week, the US was first to report inflation data for March. Here are the highlights:

• CPI accelerated to 3.5⁒, while the core held at 3.8⁒, with both readings exceeding economists' forecasts.
• Housing and gasoline costs contributed more than half of the increase in the overall CPI. Shelter prices have been sticky, contrary to the Fed's expectations.
• Core, stripped of housing, sped to 0.65⁒ month on month in March. Medical and car insurance prices surged.

Inflation readings have come higher than expected, denting market expectations of the Fed cutting interest rates in June. The market's concern is that if the rates are not cut in June, any reduction may as well get deferred to September or even December.

After the inflation data was released, several Fed officials said there was no urgency for the Fed to cut rates.

Boston Fed President Susan Collins said she saw less urgency to cut rates than she did just a few months ago because the job market has been stronger than anticipated and because easier financial conditions suggest interest rates might not be slowing the economy as much as thought.

"The risks of monetary policy being too tight have receded," she said. Recent inflation setbacks "also implies that less easing of policy this year than previously thought may be warranted."

In contrast to the US, the Indian inflation rate fell more than expected.

India's March CPI inflation print had many positives: At 4.85⁒, it was the lowest in 10 months and the first sub-5⁒ reading since October. The core inflation, at 3.3⁒, was at the lowest since 2012.

Sequentially, the overall index remained flat from the previous month, against the average month-on-month rise of 0.3⁒ in March every year since 2013. The inflation outlook is also benign.

The RBI forecasts that the CPI will average 4.5⁒ in 2024-25, down from 5.4⁒ in 2023-24.

Food inflation, which makes up nearly half of the CPI basket, eased to 8.52⁒ in March from 8.66⁒ a month ago; it has stayed above 6.00⁒ for six consecutive months.

Food inflation remains a bugbear for the RBI and those in the market expecting rate cuts.

Will RBI Blink First?

The RBI officials have been hawkish in their statements and have attempted to deter the markets from expecting rate cuts. The RBI contends that the transmission of the past rate hikes is not yet complete and has slowed down.

The other contention is that if food inflation is untamed, it will morph into generalized inflation and fuel inflation expectations.

In the April monetary policy, RBI Governor Shaktikanta Das used the elephant metaphor for 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," he said in his statement, implying inflation has to fall to 4⁒ and stay there durably for the RBI to consider rate cuts.

He said the success of managing the disinflation process should not distract the central bank from the vulnerability of the inflation trajectory.

Unless the ongoing tensions in West Asia drive inflation significantly higher, the RBI may have a complete rethink after the elections and the new government presents the full budget.

Once inflation remains around 4.5⁒, the RBI will likely lower interest rates by 50-75 basis points.

The RBI may dilute its durability condition. Inflation is expected to ease below 4⁒ in the second half, as per the RBI's projections.

From being very pedantic about the 4⁒ target, the RBI will see if inflation's momentum has weakened even if the headline number has a 4.5⁒ handle instead of a 4⁒ handle.

The RBI may not wait for the Fed to begin its rate cuts.

Governor Das recently pointed out that the RBI began its rate hikes before the Fed did. It raised interest rates by 250 basis points in contrast to the Fed's over 500-basis-point rate hike.

While the Fed has a long way to go in rate cuts over 2-3 years, the RBI may only offer shallow 50-75 basis point rate cuts to give a fillip to private capex and growth once the new government takes charge. It may not want real interest rates to remain too high for too long, with inflation averaging at 4.5⁒ next year, as per its projections.

The RBI has maintained a hawkish tone to counter the pressure on prices, likely due to the surge in currency circulation due to election spending by political parties.

Das has said India's potential growth rate may have risen.

To that extent, monetary policy worries over inflation may ease once the food prices ease.

Post-election, the RBI may have a more benign view on food inflation, as the factors driving it are related to climate and geopolitics. Food prices will not be able to hold rate cuts hostage endlessly.

This is especially so at a time when core inflation has fallen sharply.

The RBI might lead on rate cuts in the coming months, but markets won't expect the Indian central bank to turn dovish anytime soon.

Will they be in for a pleasant surprise?