From elephant to horse: What lies ahead for RBI’s monetary policy after a 5-month shift?

For Reserve Bank of India (RBI) Governor Shaktikanta Das, the battle against inflation is a pressing concern. When asked about his recent shift from using an elephant metaphor to a horse, he responded, "In a war, elephants and horses have been used historically."

Earlier, Governor Das had likened inflation to an elephant in the room, signalling it as a problem too significant to ignore. With signs of easing inflation, he suggested that the elephant had taken a walk, implying that the immediate threat had diminished, perhaps returning to more normal levels or the metaphorical forest.

Now, however, he has transitioned from describing inflation as a "slow-moving" elephant to a more "agile" horse, which now needs to be kept on a tight leash. Why this sudden shift to a more nimble analogy in just five months? Is there something the RBI Governor did not explicitly say but perhaps hinted at through the 'horse' metaphor?

Let's explore the potential reasons that could cause the inflation horse to bolt in the coming months.

Three key variables could contribute to this scenario.

First, the surprising 50 basis point interest rate cut by the US Federal Reserve last month—the first reduction since March 2020. Since the last Monetary Policy Committee (MPC) meeting, several advanced economies, including the US, Euro Area, New Zealand, Sweden, Canada, the Czech Republic, Switzerland, Iceland, and emerging markets like Mexico, Colombia, Peru, Chile, Hungary, the Philippines, Indonesia, and South Africa, have cut their policy rates. The Fed has indicated plans for additional cuts—50 basis points this year and another 100 basis points next year—depending on inflation trajectories and economic conditions. Lower interest rates in the world's largest economy typically weaken the dollar's value, which in turn exerts upward pressure on commodity prices, including oil and food products.

Second, Chinese stimulus measures are also a factor. Recently, mainland China has introduced various initiatives to combat slowing growth, attracting foreign institutional investors to its capital markets, which are perceived as attractively valued compared to other emerging markets like India. Should Chinese growth recover, the demand for commodities such as steel, copper, and oil will likely rise, driving prices higher. Notably, China is one of the largest consumers of commodities, and SBI Capital Markets has reported that the announcement of stimulus measures has triggered a rally in commodity prices, particularly metals.

Third, and perhaps most crucially, are the tensions in West Asia. Supply chains are already strained, further pushing up commodity prices. According to the RBI, Indian basket crude oil prices saw a month-on-month decline of approximately 7% in August and 5.8% in September. However, in October, prices have surged by 7.6%, reaching USD 78.84 per barrel as of October 7, 2024. "Inflationary risks have not fully abated, and rising crude oil prices amid the Iran-Israel conflict have intensified these risks. Concerns about food inflation also persist, although the harvest of Kharif crops in October and November may help alleviate some of these pressures," remarked Dhiraj Relli, MD & CEO of HDFC Securities.

Additionally, the FAO food price index for September reflected a 3% month-on-month increase, with all categories—including meat, dairy, cereals, oils, and sugar—registering a rise. A notable spike in edible oil prices has been observed since the latter half of September.

The rupee has also shown signs of weakness since January, adding further pressure to the cost of imported commodities.

In his statement, Governor Das highlighted unexpected weather events and escalating geopolitical conflicts as significant upside risks to inflation. "International crude oil prices have become volatile in October. The recent uptick in food and metal prices, as reported by the Food and Agricultural Organization (FAO) and the World Bank price indices for September, could, if sustained, contribute to further inflationary pressures," said the Governor.

Nevertheless, there has been no alteration in the inflation projection of 4.5% for 2024-25. Let’s hope the inflation horse remains under control and does not bolt from the RBI’s stable in the coming months, as the central bank prepares to cut rates.