Q2 GDP Drops, RBI Faces Pressure for Rate Cut Amid Demand Deficits and Inflation

New Delhi(The Uttam Hindu):India’s economic outlook has worsened, as the Q2 GDP growth has fallen significantly below expectations, putting increasing pressure on the Monetary Policy Committee (MPC) to consider cutting rates in its upcoming meeting. At a time when growth is far weaker than anticipated and inflation remains elevated, the MPC faces a tough decision.

Nagesh Kumar, the lone MPC member who had voted for a 25 basis point rate cut in the previous meeting, has been vindicated. Kumar had pointed out that Indian industry is struggling with demand deficits in both domestic and international markets. This mismatch in demand could explain why private investment has failed to gain momentum, despite healthy corporate balance sheets and government incentives. The Q2 GDP growth of just 5.4 percent confirms this concern. The RBI’s State of the Economy report had earlier projected a growth rate of 6.7 percent for Q2, while the MPC had anticipated 7 percent. Although a slowdown was expected, the drop to 5.4 percent is a significant shock.

With this underperformance, all eyes are now on whether the RBI will cut rates at the MPC’s meeting next week. The government and RBI have argued that the Q2 slowdown was temporary, citing factors like an extended monsoon and an unfavorable astrological period that led to deferred purchases. While these factors likely contributed, the much weaker-than-expected growth raises concerns that the slowdown may be rooted in deeper structural issues.

Additionally, the Q2 GDP shock throws into question the finance ministry’s full-year growth estimate of 6.5-7 percent, as well as the MPC’s forecast of 7.2 percent growth. There is further concern about the slowdown in bank credit growth, particularly in non-food credit, which dropped to 11.15 percent year-on-year in mid-November, down from 13.6 percent in mid-August. This decline suggests a lack of momentum in the economic recovery.

However, the biggest challenge for the MPC is inflation, which remains well above its target. October retail inflation surged to 6.2 percent, exceeding the upper limit of the RBI’s inflation tolerance. The RBI’s State of the Economy report flagged rising food prices and increasing core inflation as a cause for concern. There are signs of second-order effects from high primary food prices spilling over into other sectors. The November Flash PMI also indicates that core inflation is climbing.

The RBI report also highlighted the negative impact of high inflation on urban consumption demand and corporate earnings, as well as on capital expenditure. If inflation continues unchecked, it could undermine the prospects of the real economy, particularly in key areas like industry and exports.

In these challenging economic conditions, the MPC faces a tough decision. The combination of weaker-than-expected growth and rising inflation creates an unenviable situation for policymakers as they prepare to make crucial decisions on interest rates.