Economists and market participants are closely monitoring the potential timing of RBI’s rate cuts, prompted by a global decline in inflation over the past year and the Federal Reserve’s projection of three rate cuts in the current year. Initially, there was euphoria in the market, with expectations of up to six rate cuts by the Fed starting in March. However, stronger-than-expected economic data from the US, coupled with persistent inflation levels, has tempered these expectations. While acknowledging the likelihood of a peak rate, Fed and other central bank officials have pushed back against market assumptions. Market sentiment has since adjusted, with current expectations pointing to three rate cuts starting in June, with a 60% probability.
Influences on RBI’s Monetary Policy
Amidst Governor Mr. Das’s steadfast assertion that the inflation target remains at 4%, several factors are shaping the monetary policy landscape for the Reserve Bank of India (RBI):
1. Tight Liquidity and Withdrawal Stance: The RBI has been implementing a policy of tight liquidity and adopting a stance of liquidity withdrawal.
2. Inflation Target of 4%: The RBI’s CPI inflation target stands at 4% and the current CPI stands at 5.69% implying that rate cuts are unlikely unless significant adverse developments occur.
3. Election Year Dynamics: With the backdrop of an election year, coupled with the RBI’s projection of robust growth exceeding 6.5% for FY 25, the political landscape is influencing policy considerations.
4. Global Economic Trends: Major central banks worldwide are holding off on rate cuts, given the strength of their economies. This trend is expected to continue until the second half, with India following suit in alignment with developments in the US Federal Reserve.
5. Commodity Price Support: Elevated commodity prices, such as Brent crude oil trading above USD 75 per barrel, are anticipated to sustain imported inflation, further influencing the RBI’s policy decisions.
6. Growth: The recent fourth quarter GDP growth which was expected in the range of 6.50% to 7% came at 8.40%. Strong growth along with higher CPI may prompt RBI to maintain rates at the current level.
Global Central Banks Focus on Wage Dynamics and Inflation
Apart from the factors specific to India mentioned earlier, it is noteworthy that major Global Central Banks are closely monitoring the movement or potential trajectory of wages due to its significant impact on inflation through various channels.
Cost-push inflation occurs when wages rise, thereby increasing production costs for businesses. These heightened costs may be passed on to consumers in the form of higher prices for goods and services, particularly in industries with high labor costs such as manufacturing or services.
On the other hand, rising wages can also bolster consumer spending power, leading to increased demand for goods and services. If this demand surpasses the economy’s production capacity, it can result in demand- pull inflation, prompting businesses to raise prices to align with the heightened demand.
Moreover, wage increases can influence inflation expectations among both workers and businesses. If workers anticipate higher inflation in the future, they may demand higher wages as a compensatory measure. This phenomenon can trigger a wage-price spiral, wherein elevated wages lead to increased prices, subsequently prompting further wage demands.
In general, sustained increases in wages typically exert upward pressure on inflation, particularly if productivity growth fails to keep pace.
Wage Developments in Major Countries U.S.A.
Average hourly earnings in the U.S. rose year-over-year to 4.48% in the latest data, with a January uptick following a low of 4.3% over the previous three months. Despite current wage growth reaching 5.5% from 1% in June 2022, the Federal Reserve remains concerned, aiming to temper rate cut expectations.
EUROPE
European Central Bank (ECB) President Lagarde emphasized the ECB’s close monitoring of risk factors, including wage negotiations, which could drive inflation upwards. Wage growth in the Eurozone accelerated to 5.3% year-on-year in the third quarter of 2023, signaling mounting inflationary pressure.
JAPAN
Japan’s wage momentum has begun earlier this year, although uncertainties persist regarding the outlook. Bank of Japan (BOJ) Chief Mr. Ueda has unequivocally tied any policy change to wage settlements. The BOJ will closely monitor preliminary Shunto (wage negotiation) results expected around mid-March, ahead of the Bank’s next meeting on March 18 and 19.
This cautious optimism reflects the BOJ’s approach to ensuring sustained progress towards its 2% inflation target. As wage negotiations unfold, their outcomes will play a pivotal role in shaping the BOJ’s monetary policy decisions and determining the trajectory of Japan’s economic recovery.
U.K.
In the three months to December 2023, average weekly earnings in the United Kingdom grew by 5.8%, marking the lowest growth in nearly two years. However, pay excluding bonuses rose by 6.2% compared to the same period in 2022. This growth occurred alongside a four per cent inflation rate for the Consumer Price Index in the same month, suggesting that wages are outpacing prices. Despite this, Bank of England Deputy Governor Ben Broadbent stated that the Bank would wait for further evidence of a downward trend in wage growth before drawing conclusions. This cautious stance underscores the Bank’s commitment to maintaining price stability amid evolving wage dynamics in the United Kingdom.
Central Banks globally are closely monitoring wage developments, delaying rate cuts if significant wage increases contribute to demand-pull inflation. This cautious approach is evident in the U.S., Europe, and the U.K., where wage growth trends are influencing monetary policy decisions.
INDIA
In the Indian context, the median salary increase is projected to rise by 9.8% in 2024, reflecting a trend close to the actual salary increase of 10% observed in 2023. Notably, the Indian Banks’ Association and unions have recently reached an agreement on a significant 17% wage hike for all public sector banks, benefiting approximately nine lakh employees. This wage revision, effective from November 2022, includes provisions for arrears covering the previous 12 months.
Assessing RBI’s rate Cut Prospects
When evaluating the prospects of a rate cut by the Reserve Bank of India (RBI), it is imperative to consider the wage developments highlighted in India, alongside other pertinent factors. While several grounds traditionally supportive of a rate adjustment by the RBI, such as a potential cut by the Federal Reserve (with significant uncertainty surrounding its timing), persisting inflation levels above 5%, and robust economic growth, do not currently lend support to such a move. The interplay of these factors underscores the complexity of the decision-making process regarding monetary policy adjustments by the RBI.
Looking at the wage developments and other factors cited above, our view is that Q4 2024 will be the earliest when we see a rate cut by RBI, with probability of the move being pushed to Q1 of 2025 being equal.
Prepared by
Jayaram Krishnamurthy
Co-Founder & COO