Monetary Policy Report – October 2024

Published under Section 45ZM of the Reserve Bank of India Act, 1934 Monetary Policy Report OCTOBER 2024 Reserve Bank of India MumbaiContents Chapter I: Macroeconomic Outlook 1 I.1: Key Developments since the April 2024 MPR 1 I.2: The Outlook for Inflation 5 I.3: The Outlook for Growth 7 I.4: Balance of Risks 9 I.5: Conclusion 14 Box I.1: Monetary Policy Response to Food Inflation Under Alternative Scenarios 12 Chapter II: Prices and Costs 15 II.1: Consumer Prices 16 II.2: Drivers of Inflation 18 II.3: Costs 31 II.4: Conclusion 34 Box II.1: What Drives Housing (Rent) Inflation in India? 28 Chapter III: Demand and Output 35 III.1: Aggregate Demand 35 III.2: Aggregate Supply 47 III.3: Conclusion 56 Box III.1: Consumption Switching? Unravelling the Drivers behind Changing Consumption Patterns in India 38 Chapter IV: Financial Markets and Liquidity Conditions 57 IV.1: Domestic Financial Markets 57 IV.2: Monetary Policy Transmission 74 IV.3: Liquidity Conditions and the Operating Procedure of Monetary Policy 78 IV.4: Conclusion 81 Box IV.1: Monetary Policy Surprises and Equity Markets 65 Box IV.2: Financial Conditions Index – A High-Frequency Approach 69 Chapter V: External Environment 82 V.1: Global Economic Conditions 82 V.2: Commodity Prices and Inflation 86 V.3: Monetary Policy Stance 89 V.4: Global Financial Markets 93 V.5: Conclusion 96 Box V.1: Recent changes in Global Monetary Policy Operating Frameworks: Response to Evolving Macro-Economic Developments 89 iABBREVIATIONS AE - Advance Estimates CMIE - Centre for Monitoring Indian Economy AEs - Advanced Economies COVID-19 - Coronavirus Disease 2019 APP - Asset Purchase Programme CPB - Central Planning Bureau ARDL - Autoregressive Distributed Lag CPC - Central Pay Commission ASEAN - Association of Southeast Asian Nations CPI - Consumer Price Index ASISO - Automated Sweep-in and Sweep-out CPI-AL - Consumer Price Index for Agricultural ATM - At the money Labourers bbl - Barrel CPI-IW - Consumer Price Index for Industrial Workers BE - Budget Estimates CPI-RL - Consumer Price Index for Rural BIES - Business Inflation Expectations Labourers Survey CPs - Commercial Papers BoE - Bank of England CRAR - Capital to Risk (Weighted) Assets Ratio BoJ - Bank of Japan CRR - Cash Reserve Ratio BoR - Bank of Russia CU - Capacity Utilisation bps - Basis Points CV - Coefficient of Variation BRICS - Brazil, Russia, India, China and South DCA - Department of Consumer Affairs Africa DFM - Dynamic Factor Model BSE - Bombay Stock Exchange DFR - Deposit Facility Rate CACP - Commission for Agricultural Costs and DGCA - Directorate General of Civil Aviation Prices DGCI&S - Directorate General of Commercial CAD - Current Account Deficit Intelligence and Statistics CAG - Comptroller and Auditor General DI - Diffusion Index CASA - Current Account and Savings Account DII - Domestic Institutional Investor EBIT - Earnings Before Interest and Taxes CCIL - Clearing Corporation of India Limited EBLR - External Benchmark Lending Rate CDs - Certificates of Deposit ECB - European Central Bank CDS - Credit Default Swap ECI - Eight Core Industries CES - Constant Elasticity of Substitution EIA - Energy Information Administration CGA - Controller General of Accounts EMEs - Emerging Market Economies CI - Confidence Interval EPFO - Employees’ Provident Fund CiC - Currency in Circulation Organisation CII - Confederation of Indian Industry EPU - Economic Policy Uncertainty CLI - Composite Leading Indicator ER - Employment Rate iiiiiiMonetary Policy Report October 2024 ERR - Excess Reserve Rate H1 - First Half of the Financial Year (April-September) FAE - First Advance Estimates H2 - Second Half of the Financial Year FAO - Food and Agriculture Organization (October-March) FBIL - Financial Benchmarks India Pvt. Ltd HFI - High Frequency Indicator FCI - Financial Conditions Index HSBC - Hong Kong and Shanghai Banking FCNR - Foreign Currency Non-Resident Corporation HSD - High-Speed Diesel FDI - Foreign Direct Investment ICICI - Industrial Credit and Investment Fed - Federal Reserve Corporation of India FI - Financial Institution ICR - Interest Coverage Ratio FICCI - Federation of Indian Chambers of I-CRR - Incremental Cash Reserve Ratio Commerce & Industry IIF - Institute of International Finance FIMMDA - Fixed Income Money Market and Derivatives Association of India IIP - Index of Industrial Production FIs - Financial Institutions IL&FS - Infrastructure Leasing & Financial Services FL - Family Labour IMD - India Meteorological Department FMCG - Fast Moving Consumer Goods IMF - International Monetary Fund FOMC - Federal Open Market Committee INR - Indian Rupee FPI - Foreign Portfolio Investment/Investor IOCL - Indian Oil Corporation Limited FPO - Follow on Public Offer IPO - Initial Public Offering FRBKC - Federal Reserve Bank of Kansas City IRDAI - Insurance Regulatory and FRE - First Revised Estimate Development Authority FRL - Full Reservoir Level IRF - Impulse Response Function FRRR - Fixed Rate Reverse Repo IRFCL - International Reserves and Foreign F-TRAC - FIMMDA Trade Reporting and Currency Liquidity Confirmation System ISRO - Indian Space Research Organisation GDP - Gross Domestic Product IT - Information Technology GFCE - Government Final Consumption JGB - Japanese Government Bond Expenditure JSE - Johannesburg Stock Exchange GFCF - Gross Fixed Capital Formation LAF - Liquidity Adjustment Facility GFD - Gross Fiscal Deficit LCR - Liquidity Coverage Ratio GNDI - Gross National Disposable Income LFPR - Labour Force Participation Rate GoI - Government of India LPG - Liquefied Petroleum Gas G-Secs - Government Securities LPR - Loan Prime Rate GST - Goods and Services Tax MCLR - Marginal Cost of Funds Based Lending GVA - Gross Value Added Rate iivvAbbreviations MEP - Minimum Export Price OECD - Organisation for Economic Co-operation and Development MFs - Mutual Funds OIS - Overnight Index Swaps MGNREGA - Mahatma Gandhi National Rural Employment Guarantee Act OMOs - Open Market Operations MIBOR - Mumbai Interbank Offer Rate OMSS - Open Market Sale Scheme MIS - Market Intervention Scheme OPEC - Organization of the Petroleum Exporting Countries MLF - Marginal Lending Facility ORR - Overnight Repo Rate mmbtu - Metric Million British Thermal Unit ORRR - Overnight Reverse Repo Rate MMO - Money Market Operations OTC - Over-the-Counter M-o-M - Month-on-Month P - Provisional MOSPI - Ministry of Statistics and Programme Implementation PA - Provisional Accounts MPC - Monetary Policy Committee PADO - Public Administration, Defence and Other Services MPR - Monetary Policy Report PBoC - People’s Bank of China MRO - Main Refinance Operation PCE - Personal Consumption Expenditure MSCI - Morgan Stanley Capital International PDs - Primary Dealers MSF - Marginal Standing Facility PE - Provisional Estimates MSME - Micro, Small and Medium Enterprises PEPP - Pandemic Emergency Purchase MSP - Minimum Support Price Programme NBFCs - Non-Banking Financial Companies PFCE - Private Final Consumption Expenditure NCAER - National Council of Applied Economic Research PL - Personal Loans NDS - Negotiated Dealing System PLFS - Periodic Labour Force Survey NDS-OM - Negotiated Dealing System-Order PMI - Purchasing Managers’ Index Matching POL - Petroleum, Oil and Lubricants NDTL - Net Demand and Time Liabilities POSOCO - Power System Operation Corporation NEER - Nominal Effective Exchange Rate Limited NIM - Net Interest Margin PPAC - Petroleum Planning & Analysis Cell NPA - Non-Performing Asset PRN - Production-Weighted Rainfall Index NRE - Non-Resident External PSBs - Public Sector Banks NRO - Non-Resident Ordinary PSS - Price Support Scheme NSC - National Savings Certificate PSUs - Public Sector Undertakings NSDL - National Securities Depository Limited PVBs - Private Sector Banks NSO - National Statistical Office Q1 - First Quarter NSSO - National Sample Survey Office Q2 - Second Quarter vvMonetary Policy Report October 2024 Q3 - Third Quarter SWM - South-West Monsoon Q4 - Fourth Quarter TBs/T-Bill - Treasury Bill QIP - Qualified Institutional Placement TMA - Tractor and Mechanization Association q-o-q - Quarter-on-Quarter TOP - Tomato, Onion, and Potato QQE - Quantitative and Qualitative TREPS - Tri-party Repo Monetary Easing UK - United Kingdom RBA - Reserve Bank of Australia UMP - Unemployement Rate RBI - Reserve Bank of India UNCTAD - United Nations Conference on Trade RBNZ - Reserve Bank of New Zealand and Development RD - Revenue Deficit US - United States RE - Revised Estimates US$ - US Dollar RECO - Revenue Expenditure to Capital Outlay USA - United States of America REER - Real Effective Exchange Rate UT - Union Territory RHS - Right Hand Side VAR - Vector Auto Regression RL - Rural Labourers VAT - Value Added Tax RM - Reserve Money VECM - Vector Error Correction Model RRR - Reverse Repo Rate VRR - Variable Rate Repo S&P - Standard and Poor's VRRR - Variable Rate Reverse Repo SAAR - Seasonally Adjusted Annualised Rate WAC - Weighted Average Coupon SCBs - Scheduled Commercial Banks WACMR - Weighted Average Call Money Rate SDF - Standing Deposit Facility WACR - Weighted Average Call Rate SEBI - Securities and Exchange Board of India WADR - Weighted Average Discount Rate SGS - State Government Securities WADTDR - Weighted Average Domestic Term SIAM - Society of Indian Automobile Deposit Rate Manufacturers WALR - Weighted Average Lending Rate SIP - Systematic Investment Plan WAM - Weighted Average Maturity SLF - Standing Liquidity Facility WAMMR - Weighted Average Money Market Rate SLR - Statutory Liquidity Ratio WAY - Weighted Average Yield SME - Small and Medium-sized Enterprises SPDs - Standalone Primary Dealers WEO - World Economic Outlook SPF - Survey of Professional Forecasters WMA - Ways and Means Advances SSE - Shanghai Stock Exchange WPI - Wholesale Price Index SSI - Small Savings Instruments WTO - World Trade Organisation STU - Stocks-to-Use YCC - Yield Curve Control SVAR - Structural Vector Autoregression Y-o-Y - Year-on-Year vviiChapter I Macroeconomic Outlook I. Macroeconomic Outlook The outlook for domestic economic activity remains resilient buoyed by strong consumption and investment activities. Geopolitical conflicts, uncertain global outlook, volatile global financial markets amidst changing perceptions on monetary policy trajectories, and climate shocks are the key risks to the outlook. Monetary policy remains steadfast on aligning inflation with the target on a durable basis, setting strong foundations for a sustained period of high growth. I.1 Key Developments since the April 2024 MPR Petroleum Exporting Countries (OPEC) plus’ intent to gradually restore supplies. Of late, the US dollar Since the release of the April 2024 Monetary Policy index, sovereign bond yields and crude oil prices have Report (MPR), global economic activity has shown inched up. International prices of most agricultural resilience in the face of continuing geopolitical commodities have risen due to increase in prices of tensions and intermittent financial market volatility. vegetable oil, dairy and meat. Disinflation in headline inflation has been slow due to stubborn services inflation which is keeping core Turning to the domestic economy, real gross domestic inflation (i.e., CPI inflation excluding food & fuel) product (GDP) grew by 6.7 per cent in Q1:2024-25 elevated, relative to the headline. Several central as per the National Statistical Office (NSO). Private banks have started easing monetary policy while consumption expenditure registered a growth of others have maintained a restrictive stance, leading to 7.4 per cent, contributing 63 per cent to overall GDP divergence in policy pathways. growth. Consumption spending has been robust in Q1:2024-25, supported by rural demand which is Financial markets have been on edge, with incoming expected to improve further on the back of favourable data shifting expectations about the direction of monsoon, higher sowing activity and moderating monetary policy. Sovereign bond yields have trended inflation. Investment activity also maintained its downwards on anticipation of policy pivots. Global momentum in Q1, supported by high capacity equity markets have exhibited resilience, recovering utilisation, continued buoyancy in steel consumption quickly and regaining risk-taking appetite in spite of and capital goods imports. On the supply side, real stretched valuations and still high leverage. Capital gross value added (GVA) expanded by 6.8 per cent in flows to emerging market economies (EMEs) have Q1, with industry and services sectors being the key resumed albeit amidst heightened volatility. The drivers. US dollar index peaked in mid-June and receded thereafter on signs of cooling labour market conditions Headline consumer price index (CPI) inflation and easing inflation. Supply chain pressures have moderated to 4.4 per cent in April-August 2024 from inched up since May driven by conflicts in the Middle 5.2 per cent in H2:2023-24. Base effects continue to East. Global commodity prices declined on the back of have an outsized role in monthly inflation prints. softening prices of base metals, agricultural products, Consequently, the moderation in headline inflation and energy, however, price pressures have increased has been uneven. Core inflation was on a steadily recently amidst heightened geopolitical tensions. declining path– in May 2024, it fell to its lowest level of Brent crude oil prices, that were hovering around US 3.1 per cent in the current series (since January 2012) dollar (US$) 90 per barrel in April 2024, have since before increasing in July-August. Food price inflation, declined – even dipping below US$ 70 briefly – due on the other hand, remained elevated, averaging 6.9 to slowdown in demand and the Organization of the per cent over the last five months (April-August 2024), 11Monetary Policy Report October 2024 and contributing 72.5 per cent of headline inflation steadfast and data-dependent in their fight against during the period. Recognising the risks from volatile inflation, acknowledging that the final leg of and elevated food prices and its likely adverse impact disinflation might be tough. High frequency indicators on inflation expectations and spillovers to core for domestic economic activity showed resilience, with inflation, the Monetary Policy Committee (MPC) expectations of above normal monsoon brightening kept the policy repo rate unchanged at 6.5 per cent the prospects of agriculture sector and rural demand. through H1 and remained resolute in its commitment Investment demand in the private sector was buoyed to aligning inflation with the target, while supporting by high capacity utilisation and healthy balance growth. sheet of banks and corporates while improving world trade was expected to support external demand. The Monetary Policy Committee Meetings: April 2024 - projection of real GDP growth for 2024-25 was revised September 2024 upwards by 20 basis points from the previous meeting When the MPC met in April 2024, global economy to 7.2 per cent. In India, headline CPI inflation was showing resilience and inflation was trending moderated for three successive months to 4.8 per down. Financial markets were responding to the cent in April 2024. Food inflation was persistently timing and pace of monetary policy trajectories, with high while core inflation had fallen to historic lows. heightened uncertainty pushing up gold prices on safe Nevertheless, the future inflation trajectory remained haven demand. The domestic economic momentum uncertain due to supply shocks, input cost pressures appeared strong, supported by healthy bank and and crude oil price volatility. The projection of CPI corporate sector balance sheets and upbeat business inflation for 2024-25 was retained at 4.5 per cent. The and consumer sentiments. Hence, the real GDP MPC noted that while the growth-inflation balance growth projection for 2024-25 was retained at 7 per had moved favourably since its previous meeting, cent. CPI headline inflation had softened in January- risks to inflation remain from recurring food price February 2024 from its December high although food shocks and monetary policy has to stay watchful of inflation edged up. The MPC noted the uncertainties the spillovers of food price pressures to core inflation around the inflation trajectory stemming from and inflation expectations. Accordingly, the MPC weather-driven food price shocks, cost push pressures, decided by a majority of 4-2 to keep the policy rate firming crude oil prices due to geopolitical tensions unchanged at 6.5 per cent. The MPC voted with a 4-2 and volatility in financial markets, and retained the majority to continue with the stance of withdrawal of projection of CPI inflation for 2024-25 at 4.5 per cent. accommodation. The MPC observed that food price pressures have In the run up to August 2024 meeting, headline been interrupting the ongoing disinflation process, inflation, after remaining steady at 4.8 per cent posing challenges for the final descent of inflation to during April and May 2024, increased to 5.1 per cent the target. Considering that the path of disinflation in June 2024, primarily driven by the food component has to be sustained till inflation reaches the 4 per cent even though fuel prices remained in deflation target on a durable basis, MPC also decided, by a 5-1 and core inflation touched new lows. Assuming a majority, to keep the policy repo rate unchanged at normal monsoon, CPI inflation projection for 2024- 6.5 per cent. The MPC decided by a majority of 5-1 to 25 was retained at 4.5 per cent. Domestic economic remain focused on withdrawal of accommodation so activity was strengthening, with the pick-up in as to ensure that inflation progressively aligns with southwest monsoon rainfall and improved spatial the target, while supporting growth. spread translating into higher kharif sowing. Other At the time of June 2024 meeting, global growth high frequency indicators suggested expansion in was sustaining momentum. Central banks remained services activity. A revival in private consumption 2Chapter I Macroeconomic Outlook has been underway with rural demand catching up April 2024 while two major advanced economies (AEs) with urban consumption. The pickup in investment the US and the United Kingdom - have begun their activity gathered strength as reflected by expansion in policy pivot in the second half of 2024. steel consumption, high capacity utilisation and the Macroeconomic Outlook government’s thrust on infra-spending. The projection Chapters II and III analyse macroeconomic of real GDP growth for 2024-25 was retained at 7.2 developments relating to inflation and economic per cent. The MPC observed that risks from volatile activity during H1:2024-25 (April-September 2024). and elevated food prices remain high, which may Turning to the baseline assumptions, international adversely impact inflation expectations and result crude prices exhibited sizeable two-way movements in spillovers to core inflation. Accordingly, the MPC in H1, receding from their five-month peak of US$ decided by a majority of 4-2 to keep the policy repo dollar (US$) 91 per barrel in early April 2024 to US$ rate unchanged at 6.5 per cent while retaining the 77 per barrel by early June 2024 on slowing demand stance of withdrawal of accommodation. in Organization for Economic Cooperation and The MPC’s voting pattern reflects the diversity in Development (OECD) countries and easing supply individual members’ assessments, expectations and conditions. In September 2024, they were settling policy preferences - a characteristic also reflected in around US$ 71-78 per barrel. While global growth voting patterns of other central banks (Table I.1). With uncertainties on the demand side and geopolitical the emerging view that the disinflation process is in its tensions on the supply side impart significant final leg, a larger number of central banks have begun volatility to the outlook (Charts I.1a and I.1b), easing an easing cycle while others have retained policy rates at restrictive levels. EME central banks that began Table I.2: Baseline Assumptions for Projections policy rate easing have undertaken larger cuts since Indicator MPR April 2024 MPR October 2024 Crude Oil (Indian basket) US$ 85 per barrel US$ 80 per barrel during 2024-25 during H2:2024-25 Table I.1 Monetary Policy Committees and Exchange rate ₹ 83/US$ during ₹ 83.5/US$ during Policy Rate Voting Patterns 2024-25 H2:2024-25 Country Policy Meetings: April 2024 - September 2024 Monsoon Normal for 2024-25 Normal for 2025-26 Total Meetings Meetings Variation Global growth 3.1 per cent in 2024 3.2 per cent in 2024 meetings with full without in policy 3.2 per cent in 2025 3.3 per cent in 2025 consensus full rate (basis Fiscal deficit To remain within BE To remain within BE consensus points) (per cent of GDP) 2024-25 2024-25 Brazil 4 3 1 0 Centre: 5.1 Centre: 4.9 Combined: 7.7 Combined: 7.3 Chile 5 4 1 -175 Domestic macroeconomic/ No major change No major change Colombia 4 0 4 -200 structural policies during Czech Republic 4 2 2 -150 the forecast period Hungary 5 5 0 -150 Notes: 1. The Indian basket of crude oil represents a derived numeraire comprising sour grade (Oman and Dubai average) and sweet India 3 0 3 0 grade (Brent) crude oil. 2. The exchange rate path assumed here is for the purpose of Japan 4 3 1 15 generating the baseline projections and does not indicate any South Africa 3 2 1 -25 ‘view’ on the level of the exchange rate. The Reserve Bank is guided by the objective of containing excess volatility in the Sweden 4 4 0 -75 foreign exchange market and not by any specific level of and/or Thailand 3 0 3 0 band around the exchange rate. 3. BE: Budget estimates. UK 4 0 4 -25 4. Combined fiscal deficit refers to that of the Centre and States taken together. US 4 3 1 -50 Sources: RBI estimates; Budget documents; and International Monetary Sources: Central bank websites. Fund (IMF). 33Monetary Policy Report October 2024 Chart I.1: Crude Oil Prices Sources: Bloomberg; US Energy Information Administration (EIA); and Petroleum Planning & Analysis Cell. global demand-supply refinery divergences have forecast for 2025 to 3.3 per cent in its July World reduced the wedge between global petroleum product Economic Outlook (WEO) compared with April 2024 prices and crude prices (Chart I.1c). Considering these update. With modest recovery on the global front, factors, crude prices (Indian basket) are assumed at the projection for global growth in 2024 and 2025 is US$ 80 per barrel in the baseline as compared with still below the historical annual average1 of 3.8 per US$ 85 in the April 2024 MPR (Table I.2). cent. Inflation is projected to fall from 5.9 per cent in 2024 to 4.4 per cent in 2025. The pace of decline in Second, the nominal exchange rate of the Indian rupee inflation to targets, however, is likely to be faster in (₹) saw two-way movements in the range of ₹83-84 per US$ in H1, with a depreciating bias since July 2024. Chart I.2: Global GDP Growth and Inflation Taking into consideration the uncertainty around US dollar movements, the ebbs and flows of global capital flows and international crude oil prices, the exchange rate is assumed at INR 83.5 per US dollar in the baseline as against INR 83 in the April 2024 MPR. Third, repeated geopolitical tensions, rekindled fears of a potential recession in key economies and financial market volatility in response to monetary policy divergence weigh heavily on global growth prospects. The global composite purchasing managers' index (PMI) has exhibited moderation since May 2024 with PMI manufacturing in contraction zone since July 2024. The IMF retained the global growth estimate for 2024 at 3.2 per cent and revised upwards its growth Source: World Economic Outlook July 2024 Update, IMF. 1 Historical annual average during 2000 - 2019. 4Chapter I Macroeconomic Outlook AEs vis-à-vis EMEs (Chart I.2). Global trade growth is Chart I.3: Inflation Expectations of Households estimated to rebound to 3.1 per cent in 2024 from 0.8 per cent in 2023, notwithstanding the surge in cross- border trade restrictions that pose risks to the global trade outlook. I.2 The Outlook for Inflation In H1:2024-25 (up to August), headline inflation remained within the tolerance band while food inflation remained elevated and persistent (Chapter II). In the September 2024 round of the Reserve Bank’s survey2, the three months and one year ahead median inflation expectations of urban households reduced by 20 and 10 bps to 9.2 per cent and 10.0 per cent, respectively, vis-à-vis the previous round. The proportion of respondents expecting the general price level to increase by more than the current rate Source: Inflation Expectations Survey of Households, RBI. declined for both horizons vis-à-vis the previous round (Chart I.3). growth momentum to continue in Q3:2024-25 (Chart I.4a).3 Services sector companies and infrastructure Manufacturing firms polled in the July - September firms expect input cost pressures to persist and selling 2024 round of the Reserve Bank’s industrial outlook survey expect pressures from cost of raw materials prices growth to moderate in Q3:2024-25 (Charts to continue, with some softening and selling price I.4b and I.4c).4 In the PMI surveys for September Chart I.4: Expectations for Cost of Raw Materials/Inputs and Selling Prices Note: Net response is the difference between the share of respondents reporting optimism and those reporting pessimism. The range is -100 to 100. A positive/ negative value of net response is considered as optimistic/pessimistic from the view point of respondent firms. Therefore, higher positive values of selling prices indicate increase in output prices while lower values for the cost of raw materials/cost of inputs indicate higher input price pressures and vice versa. Sources: Industrial Outlook Survey and Services and Infrastructure Outlook Survey, RBI. 2 The Reserve Bank’s inflation expectations survey of households is being conducted in 19 cities since March 2021 (18 cities in the previous rounds) and the results of the September 2024 round are based on responses from 6,076 households. 3 The results of the July- September 2024 round of the industrial outlook survey are based on responses from 1,300 companies. 4 Based on 622 services companies and 139 infrastructure firms polled in the July-September 2024 round of the services and infrastructure outlook survey. 55Monetary Policy Report October 2024 Chart I.5: Inflation Expectations of Professional Forecasters Sources: Survey of Professional Forecasters, RBI; and National Statistical Office. 2024, input price indices of both manufacturing and for the inflation outlook. Nevertheless, rising global services firms increased vis-à-vis the previous month supply chain pressures, adverse weather events, while output prices decreased for both firms. Table I.3: Projections - Reserve Bank and Professional forecasters surveyed by the Reserve Bank Professional Forecasters in September 2024 expect headline CPI inflation to (Per cent) increase from 4.0 per cent in Q2:2024-25 to 4.6 per 2024-25 2025-26 Reserve Bank’s Baseline Projections cent in Q3, 4.4 per cent in Q4 and 4.2-4.5 per cent in Inflation, Q4 (y-o-y) 4.2 4.1 H1:2025-26 (Chart I.5a and Table I.3).5 Core inflation Real GDP growth 7.2 7.1 (i.e., CPI excluding food and beverages, pan, tobacco Median Projections of Professional Forecasters and intoxicants, and fuel and light) is expected to Inflation, Q4 (y-o-y) 4.4 - successively increase from 3.5 per cent in Q2:2024- Real GDP growth 6.9 6.7 Gross domestic saving (per cent of GNDI) 30.0 30.3 25 to 3.9 per cent in Q3 and is expected to remain Gross capital formation (per cent of GDP) 33.5 33.5 between 4.2-4.3 per cent in the next three quarters.In Credit growth of scheduled commercial banks 13.5 13.0 the September 2024 round, their 5-year ahead expected Combined gross fiscal deficit (per cent of GDP) 7.9 7.4 Central government gross fiscal deficit inflation remained unchanged at 4.5 per cent, while 4.9 4.5 (per cent of GDP) their 10-year ahead expectations moderated to 4.3 per Repo rate (end-period) 6.25 - cent as compared to 4.5 per cent in the previous round Yield on 91-days treasury bills (end-period) 6.4 6.2 Yield on 10-year central government securities (Chart I.5b). 6.6 6.5 (end-period) Looking ahead, evolving food inflation dynamics will Overall balance of payments (US$ billion) 48.8 37.1 Merchandise exports growth 3.4 5.5 impinge upon the outlook for inflation. The above Merchandise imports growth 4.6 5.9 normal south-west monsoon rainfall, significantly Current account balance (per cent of GDP) -1.0 -1.0 higher reservoir levels as compared to decadal average Note: GNDI: Gross National Disposable Income. Sources: RBI staff estimates; and Survey of Professional Forecasters and higher kharif sowing vis-a-vis last year bode well (September 2024). 5 47 panellists participated in the September 2024 round of the Reserve Bank’s survey of professional forecasters. 6Chapter I Macroeconomic Outlook uneven distribution of rainfall; prolonged geopolitical Chart I.6: Projection of CPI Inflation (y-o-y) conflicts and resultant supply disruptions; recent uptick in food and metal prices; volatility of crude oil prices; and adverse weather events. The downside risks could materialise from an early resolution of geopolitical conflicts; weakening of global demand accompanied by further easing of global food and commodity prices; improvement in supply conditions; and proactive supply side measures by the government. I.3 The Outlook for Growth Domestic economic activity remains resilient. Note: The fan chart depicts uncertainty around the baseline projection path. The baseline projections are conditioned upon the assumptions set out in Table I.2. Improved performance of industrial sector, upturn The thick red shaded area represents 50 per cent confidence interval, implying that there is 50 per cent probability that the actual outcome will be within in investment activity, above normal monsoon, pick the range given by the thick red shaded area. Likewise, for 70 per cent and 90 up in rural demand, high capacity utilisation, healthy per cent confidence intervals, there is 70 per cent and 90 per cent probability, respectively, that the actual outcomes will be in the range represented by the balance sheets of banks and corporates, and the respective shaded areas. Source: RBI staff estimates. government’s continued thrust on infrastructure spending augur well for the growth outlook. volatile food prices and continuing geopolitical strife Uncertain global economic outlook, lingering remain key risks. Taking into account the initial geopolitical conflicts, rising supply chain pressures, conditions, signals from forward-looking surveys and and volatile global financial conditions, however, estimates from time-series and structural models6, weigh heavily on the outlook to the downside. CPI inflation is projected to average 4.5 per cent in 2024-25 – 4.1 per cent in Q2, 4.8 per cent in Q3 Turning to the key messages from forward-looking and 4.2 per cent in Q4, with risks evenly balanced surveys, consumer confidence (the current situation (Chart I.6). The 50 per cent and the 70 per cent index) improved in the September 2024 survey round confidence intervals for headline inflation in Q4:2024- vis-à-vis the previous round on account of better 25 are 3.2-5.2 per cent and 2.6-5.8 per cent, respectively. perceptions about the general economic, employment, For 2025-26, assuming a normal monsoon, and no and income conditions. Consumers’ optimism for further exogenous or policy shocks, structural model the year ahead, measured by the future expectations estimates indicate that inflation will average 4.1 per index, also improved in the latest round vis-à-vis the cent with 4.3 per cent in Q1, 3.7 per cent in Q2, 4.2 previous one (Chart I.7).7 per cent in Q3 and 4.1 per cent in Q4. The 50 per cent Optimism in the manufacturing sector for Q3:2024-25 and the 70 per cent confidence intervals for headline improved in the July- September 2024 round of the inflation in Q4:2025-26 are 2.8-5.4 per cent and 2.1-6.1 Reserve Bank’s industrial outlook survey (Chart I.8a). per cent, respectively. Services and infrastructure companies continue to The baseline forecasts are subject to several upside maintain a highly optimistic outlook for Q3:2024-25 and downside risks. The upside risks emanate from (Charts I.8b and I.8c). 6 Joice John, Deepak Kumar, Asish Thomas George, Pratik Mitra, Muneesh Kapur and Michael Debabrata Patra (2023), “A Recalibrated Quarterly Projection Model (QPM 2.0) for India”, Reserve Bank of India Bulletin, February, Volume LXXVII(2), pp.59-77. 7 The Reserve Bank’s consumer confidence survey is being conducted in 19 cities since March 2021 (13 cities in the previous rounds) and the results of the September 2024 round are based on responses from 6,087 respondents. 77Monetary Policy Report October 2024 Chart I.7: Consumer Confidence Table I.4: Business Expectations Surveys Item NCAER FICCI Dun and CII Business Overall Bradstreet Business Confidence Business Composite Confidence Index (July Confidence Business Index 2024) Index (May Optimism (October 2024) Index (July 2024) 2024) Current level of 149.8 73.7 78.9 68.2 the index Index as per 70.9 75.9 67.3 previous survey 138.2 % change (q-o-q) 8.4 3.9 3.9 1.3 sequential % change (y-o-y) 17.0 18.1 12.6 1.6 Notes: 1. NCAER: National Council of Applied Economic Research. 2. FICCI: Federation of Indian Chambers of Commerce & Industry. 3. CII: Confederation of Indian Industry. 4. Dun and Bradstreet Composite Business Optimism Index and CII Business Confidence Index are for Q2:2024-25, NCAER Source: Consumer Confidence Survey, RBI. Business Confidence Index is for Q1:2024-25, and FICCI Overall Business Confidence Index pertain to Q4:2023-24. Recent surveys by other agencies report sequential Sources: NCAER, FICCI, CII and Dun & Bradstreet Information Services improvement in business expectations relative to India Pvt. Ltd. the previous round (Table I.4). Manufacturing and growth at 6.9-7.0 per cent during 2024-25 and 6.6-6.7 services firms in the PMI surveys for September 2024 per cent during H1:2025-26 (Chart I.9 and Table I.3). remained upbeat for the year ahead though a marginal deceleration in expectations is observed vis-à-vis the Real GDP growth exceeded 8 per cent growth in previous month for manufacturing firms. the first three quarters of 2023-24 before dipping Professional forecasters polled in the September 2024 marginally to 7.8 per cent in Q4. Real GDP growth round of the Reserve Bank’s survey expected real GDP of 6.7 per cent in Q1:2024-25 is reflective of the Chart I.8: Business Assessment and Expectations Sources: Industrial Outlook Survey and Services and Infrastructure Outlook Survey, RBI. 8Chapter I Macroeconomic Outlook Chart I.9: Professional Forecasters' Projection of Chart I.10: Projection of Growth in Real GDP (y-o-y) Real GDP Growth Note: The fan chart depicts uncertainty around the baseline projection path. The baseline projections are conditioned upon the assumptions set out in Table I.2. The thick green shaded area represents 50 per cent confidence interval, implying that there is 50 per cent probability that the actual outcome will be within the range given by the thick green shaded area. Likewise, for 70 per cent and 90 per cent confidence intervals, there is 70 per cent and 90 per cent probability, respectively, that the actual outcomes will be in the range represented by the Sources: Survey of Professional Forecasters, RBI and National Statistical Office. respective shaded areas. underlying momentum in key drivers of the economy and earlier than anticipated easing of global financial viz., private consumption and investment. Taking conditions. On the contrary, further escalation in into account the baseline assumptions, survey geopolitical tensions; volatility in international indicators and model forecasts, real GDP growth is financial markets and geoeconomic fragmentation; expected at 7.2 per cent in 2024-25 with 7.0 per cent deceleration in global demand; frequent weather- in Q2; 7.4 per cent both in Q3 and Q4 - with risks related disturbances due to climate change; and evenly balanced around the baseline (Chart I.10 and supply chain disruptions pose downside risks to the Table I.3). For 2025-26, assuming a normal monsoon baseline growth path. and no major exogenous or policy shocks, structural I.4 Balance of Risks model estimates indicate real GDP growth at 7.1 per cent, with Q1 at 7.3 per cent, Q2 at 7.2 per cent, Q3 The baseline projections of growth and inflation and Q4 both at 7.0 per cent. are conditional on assumptions of the future path of key domestic and global macroeconomic variables There are upside and downside risks to this baseline growth path. The upside risks emanate from robust set out in Table 1.2. These baseline assumptions are, government capex and revival in private investment; however, subject to uncertainties emanating from improved prospects of agricultural sector due prolonged geopolitical conflicts, volatility in global to favourable monsoon rainfall; strengthening financial markets and recurrent adverse climate manufacturing and services sector activity sustained events. In this context, this section explores the by strong domestic demand; retreating global and plausible alternative scenarios to assess the balance domestic inflation; improvement in global trade; of risks around the baseline projections. 99Monetary Policy Report October 2024 (i) Global Growth Uncertainties growth and inflation could turn out to be higher by around 15 bps and 7 bps, respectively (Charts Global economic activity is subject to uncertainties I.11a and I.12a). going forward. Policy divergence among major central banks could trigger heightened volatility in global (ii) International Crude Oil Prices financial markets, with spillovers to emerging market Global crude oil prices have exhibited some economies. Services price and wage inflation remain moderation, with Brent crude falling from a high areas of concern for the last mile of disinflation which of US$ 93 per barrel in mid-April 2024 to US$73 per might keep global interest rates higher for longer, barrel by end-September. Global growth recovery, with adverse impact on global growth prospects. continuation of geo-political tensions and non- The global economic outlook is also subject to reversal of production cut by OPEC plus may put headwinds from prolonged geopolitical and trade upward pressure on crude oil prices. In this scenario, tensions, supply chain disruptions and swings assuming crude oil price to be 10 per cent above the in economic policies resulting from impending baseline and full pass-through to domestic product elections in major economies. In case these downside prices, domestic inflation could be higher by 30 bps risks materialise, and, if global growth is 100 bps and growth weaker by around 15 bps, respectively. lower than the baseline, domestic growth and Conversely, early resolution of geopolitical tensions, inflation could be lower than baseline projections by weak global demand, higher production from non- around 30 bps and 15 bps, respectively. If, however, OPEC economies along with unwinding of production there is faster convergence in global disinflation cuts by OPEC plus may soften crude oil prices. If and alignment in monetary policy paths going crude oil prices fall by 10 per cent relative to the forward, recovery in global trade and resolution of baseline, inflation could ease by around 30 bps with geopolitical tensions, there can be an upside to global a boost of 15 bps to India’s real GDP growth (Charts growth. If global growth is higher by 50 bps, domestic I.11a and I.12a). Chart 1.11: Impact of Risk Scenarios on the Baseline Inflation Path Source: RBI staff estimates. 10Chapter I Macroeconomic Outlook Chart 1.12: Impact of Risk Scenarios on the Baseline Growth Path Source: RBI staff estimates. (iii) Exchange Rate (iv) Food Inflation The Indian Rupee (INR) has remained steady against Food inflation remained persistently high in H1:2024- the US dollar, being least volatile among major EME 25, driven by high prices in cereals and pulses along currencies in recent months. Going ahead, restrictive with large shocks to vegetable prices triggered by monetary policy by major AEs to achieve the last mile recurrent adverse climate events of rising intensity. Further, food prices may be subject to extreme of disinflation could limit attractiveness of EME assets weather events such as excess rains and floods and trigger reversal of capital flows. Crude oil and affecting kharif crops, unseasonal rains typically other global commodity prices could also harden in associated with extreme La Niña conditions, which comparison with the baseline. In this scenario, if INR may result in damage of winter crops and perishables. depreciates by 5 per cent over the baseline, inflation In such a scenario, there could be upward pressures could be higher by around 35 bps while GDP growth on food prices and could raise headline inflation by could edge up by around 25 bps through short term around 50 bps over the baseline. Persistent shocks stimulation of exports. On the other hand, the Indian to food inflation warrant a cautious approach by economy remains the fastest growing major economy monetary policy to contain spillover effects (Box I.1). globally and is poised to play an important role in On the other hand, kharif sowing remained robust, revival of global growth. These developments, along with higher acreage for major crops. Reservoir levels, with robust domestic macroeconomic fundamentals, too, are higher than both last year’s levels and the inclusion of government bonds in global indices, and decadal average, which augurs well for the rabi faster than anticipated monetary policy easing by AEs season. These developments along with effective would attract foreign investors. In this scenario, if the supply management measures may result in easing INR appreciates by 5 per cent relative to the baseline, of food inflation pressures and could lower headline inflation and GDP growth could moderate by around 35 inflation by 50 bps compared with the baseline bps and 25 bps, respectively (Charts I.11b and I.12b). (Charts I.11b and I.12b). 1111Monetary Policy Report October 2024 Box I.1: Monetary Policy Response to Food Inflation Under Alternative Scenarios The implications of food inflation for monetary policy no policy response. In the event of repeated shocks are conditional on the size and duration of shocks to food to food inflation, however, there may be spillover to prices and their transmission to headline inflation. The core inflation through elevated second round effects, direct or first round impact of food inflation shocks is requiring substantive monetary policy action to stabilise observed as a change in headline CPI inflation, given the prices. dominant share of food items in the average household Scenario 2 illustrates the relative effect of repeated consumption basket. In the event of repeated and/ food inflation shocks (from scenario 1) in the presence or persistent food price shocks, price pressures may of buoyant aggregate demand conditions as against a spillover to other components through shifts in inflation situation with slack in demand. In the event of robust expectations (Das, 2024; Patra, et.al., 2024) and correction demand conditions, the spike in core inflation will be in relative prices. These are the indirect or second-round compounded, warranting more aggressive monetary effects of food inflation. policy action. In case of slack demand conditions, the While the first-round effects are largely invariant to pass-through of repeated shocks from food to core monetary policy, the second-round effects fall within inflation will be moderate, meriting lesser urgency for its ambit. Therefore, prudent monetary policy must monetary policy tightening. assess persistence of shocks to food inflation, their Finally, Scenario 3 illustrates the impact of a series of direct and indirect effects, and the relative efficacy of repeated food inflation shocks (from scenario 1) in the interest rate changes in moderating these impulses. case of a perfectly credible central bank. Higher credibility This assumes importance in the broader macroeconomic leads to better anchoring of inflation expectations of context that accounts for contemporaneous aggregate economic agents, which may lead to restricted pass- demand conditions as well as the credibility of the through of higher costs to prices and therefore warranting central bank in anchoring inflation expectations. This less tightening of monetary policy. If the central bank general equilibrium approach are modelled by using the credibility is low, economic agents may develop adaptive Quarterly Projection Model 2.0 (John et. al., 2023)8. expectations and therefore inflationary shocks may pass- through without friction, warranting more aggressive Scenario 1 models the impact of a transitory shock policy rate action to stabilise the economy. compared to repeated shocks to food inflation. Transitory shocks may largely be seen through as they These simulations suggest that while transitory shocks to tend not to pass through to core inflation, warranting food inflation can largely be ignored by monetary policy, (Contd.) 8 Core inflation ( ) is postulated as a function of one quarter ahead expected y-o-y core inflation ( ), its own past ( ), non-agricultural output gap ( ), real exchange rate gap ( ) and spillovers from fuel and food components. Inflation expectation is represented as a weighted sum of one-quarter lagged core inflation and model-based one quarter ahead rational expectation. The weights depend on the stock of policy credibility ( ). can range between 0 and 1; 0 indicates no credibility, in which case expectations are completely backward looking; and 1 indicates perfect credibility, in which case inflation expectations are perfectly forward looking. The policy repo rate equation follows an inflation-forecast based Taylor-type reaction function with an interest rate smoothing parameter. where is the policy repo rate, is the natural rate of interest, is the inflation target, and are the three quarters ahead core and headline inflation forecasts, respectively. The above three equations are a part of the entire system of equations described the Quarterly Projection Model (QPM 2.0). 12Chapter I Macroeconomic Outlook repeated shocks do pose a challenge. If monetary policy expectations and consequently a more durable upward does not respond to the second-round effects of repeated drift in core inflation, warranting more aggressive shocks to food inflation, it risks unanchoring of inflation monetary policy to achieve disinflation in the future. Chart I.1.1: Impact of food inflation shocks Scenario 1: Transitory shock versus repeated shocks to food inflation Scenario 2: Repeated shocks to food inflation in a buoyant versus slackening economy Scenario 3: Repeated shocks to food inflation with a perfectly credible and with imperfect central bank crediblity References: S. Das (2024). “Governor’s Statement: Monetary Policy Statement (August 6-8) 2024-25”. RBI Bulletin, August 2024, Vol. 78(8). J. John, Kumar D., George A.T., Mitra P., Kapur M., & Patra, M.D. (2023). “A Recalibrated Quarterly Projection Model (QPM 2.0) for India”. RBI Bulletin, February 2023, Vol. 77(2). M.D. Patra, John J., & George, A.T. (2024). “Are Food Prices Spilling Over?”. RBI Bulletin, August 2024, Vol. 78(8). 1133Monetary Policy Report October 2024 I.5 Conclusion downward trajectory and is expected to moderate further in 2024-25, though the pace may be slow and Domestic economic activity is expected to remain uneven. Core inflation has bottomed out but remains robust on the back of strong fundamentals. The subdued, supported by disinflationary monetary revival of private consumption is buoyed by receding policy. The last mile of disinflation is contingent inflation and pick-up in rural demand is expected upon reining in food inflation and checking its to be its mainstay. The Government’s capex push spillover impact on inflation expectations and on infrastructure, upturn in investment activity, core inflation. Monetary policy remains steadfast improved prospects of agricultural sector, strong on aligning inflation with the target. Geopolitical corporate and bank balance sheets and improved conflicts, uncertain global outlook, volatile global outlook of global growth and trade are further aiding financial markets, and climate shocks remain key the growth momentum. Headline inflation is on a risks to the growth and inflation outlook. 14Chapter II Prices and Costs II. Prices and Costs Headline CPI inflation after remaining sticky till June 2024, fell sharply thereafter buoyed by favourable base effects. The wedge between headline and core inflation widened further in June, before moderating in July- August. Input costs have remained subdued while rural wages and manufacturing staff cost growth decelerated. Headline consumer price index (CPI) inflation1 to 3.6-3.7 per cent, buoyed by large favourable base remained sticky at around 5 per cent during March to effects in July, which also pulled food inflation down June 2024, with key groups displaying considerable to 5.1-5.3 per cent. Core inflation edged up to around divergence. Food inflation edged up from an elevated 3.4 per cent in July-August, primarily on account of a level of 7.8 per cent in February 2024 to 8.4 per cent pick-up in core services inflation, while deflation in by June under the impact of repeated supply-side fuel prices intensified (Chart II.1). shocks. Deflation in fuel prices deepened from (-)0.8 The Reserve Bank of India (RBI) Act enjoins the RBI per cent in February to (-)3.6 per cent in June. Core to set out deviations of actual inflation outcomes (CPI excluding food and fuel) inflation2 softened from from projections, if any, and explain the underlying 3.4 per cent to 3.1 per cent over the same period, the reasons thereof. The April 2024 MPR had projected lowest reading recorded in the current CPI (2012=100) series so far. The wedge between headline and core inflation at 4.9 per cent in Q1:2024-25 and 3.8 per inflation widened, from 1.7 percentage points in cent in Q2:2024-25 (Chart II.2). Actual inflation February 2024 to 2.0 percentage points in June. In outcomes have largely mirrored these projections. July-August 2024, headline CPI inflation fell sharply The projections of a significant softening of inflation Chart II.1: CPI Inflation (y-o-y) Chart II.2: CPI Inflation (y-o-y): Projection versus Actual *: Projections for entire Q2:2024-25 vis-à-vis actual average inflation for July- August 2024. Sources: National Statistical Office (NSO); and RBI staff estimates. Sources: NSO; and RBI staff estimates 1 Headline inflation is measured by year-on-year (y-o-y) changes in the all-India consumer price index (CPI) produced by the National Statistical Office (NSO). 2 Core CPI, i.e., CPI excluding food and fuel is worked out by eliminating the groups ‘food and beverages’ and ‘fuel and light’ from the headline CPI. 1155Monetary Policy Report October 2024 in Q2 (July to September), induced by large favourable favourable base effects. In the second phase from July, base effects in July, was also confirmed by actual CPI price momentum remained firm across food and inflation outcomes. The projections for Q2 (July- core groups, while statistical gains from favourable September) had also factored in a likely pick-up in base effects pulled down headline CPI inflation by inflation in September due to adverse base effects. 1.5 percentage points to 3.6 per cent. In August, the modest increase in headline inflation by 5 basis points II.1 Consumer Prices (bps) to around 3.7 per cent reflected base effects only Inflation dynamics in 2024-25 so far (April to August) as the overall prices remained unchanged (Chart II.3). have undergone two distinct phases. First, after The distribution of CPI inflation in 2024 so far moderating to 4.9 per cent in March from 5.1 per cent (January-August) reflects a lower median and mean in February, on favourable base effects and a sharp along with lower standard deviation than a year fall in fuel price momentum3, headline inflation ago when large and multiple food price shocks had remained steady at 4.8 per cent in April-May and played an outsized role (Chart II.4). Stickiness in edged up thereafter to 5.1 per cent in June due to a headline inflation between January-June 2024 was sharp pick up in price momentum triggered by an accompanied by a considerable divergence in food, increase in food prices, notwithstanding significant fuel and core inflation trajectories. In July-August, Chart II.3: CPI Inflation – Momentum and Base Effects Sources: NSO; and RBI staff estimates. 3 A change in CPI year-on-year (y-o-y) inflation between any two months is the difference between the current month-on-month (m-o-m) change in the price index (momentum) and the m-o-m change in the price index 12 months earlier (base effect). For more details, see Box I.1 of the MPR, September 2014. 16Chapter II Prices and Costs Chart II.4: Average CPI Inflation (y-o-y) Chart II.5: CPI Sub-Group/Group Inflation Range (Kernel Density Estimates) (y-o-y) Sources: NSO; and RBI staff estimates. Sources: NSO; and RBI staff estimates. a fall in food inflation led to narrowing of these March 2024, headline CPI DI dipped in April-May divergences (Chart II.5). across both goods and services components. During Diffusion indices (DIs)4 remained in high expansionary June-August 2024, headline CPI DI edged up due to zone between March and August 2024, indicative of wider dispersion of price increases, first in goods and positive price increases across a broad spectrum of thereafter in services (Chart II.6a). Threshold DI5 – the CPI basket. After recording a transient uptick in for price increases in excess of 4 per cent as well as Chart II.6: CPI Diffusion Indices (M-o-M Seasonally Adjusted) Sources: NSO; and RBI staff estimates. 4 The CPI diffusion index, a measure of dispersion of price changes, categorises items in the CPI basket according to whether their m-o-m seasonally adjusted prices have risen, remained stagnant or fallen over the previous month. The higher the reading above 50, the broader is the expansion or generalisation of price increases; the further is the reading below 50, the broader is the price decline across items. 5 Threshold diffusion indices capture the dispersion of price increases in CPI basket beyond the specified saar thresholds of 4 per cent and 6 per cent. 1177Monetary Policy Report October 2024 6 per cent on a seasonally adjusted annualised rate to overall inflation - after being the major driver of (saar) basis – continued to remain well below the 50 inflation in the last four successive quarters - and level mark, indicating little incidence of any broad- from the disinflationary impact of past monetary basing of such price momentum (Chart II.6b). policy actions (Chart II.7a). Goods inflation (with a weight of 76.6 per cent in the II.2 Drivers of Inflation overall CPI) contributed around 88 per cent of headline A historical decomposition of inflation using a inflation between March and June 2024 and around vector autoregression (VAR)6 model indicates that 82 per cent in July and August 2024 (Chart II.7b). The the moderation in inflation in Q2:2024-25 stemmed contribution of services (with a weight of 23.4 per from the negative contribution of supply side shocks cent) edged up over this period due to the pick-up Chart II.7: Drivers of CPI Inflation Sources: NSO; and RBI staff estimates. 6 Historical decomposition estimates the contribution of each shock to the movements in inflation over the sample period (Q4:2010-11 to Q4:2024-25) based on a vector autoregression (VAR) with the following variables (represented as the vector Y) – crude oil prices (US$ per barrel); exchange rate (INR t per US$), asset price (BSE Sensex), CPI; the output gap; rural wages; the policy repo rate; and money supply (M). All variables other than policy repo rate 3 are y-o-y growth rates. The VAR can be written in reduced form as: Y = c + A Y + e; where e represents a vector of shocks. Using Wold decomposition, t t-1 t t Y can be represented as a function of its deterministic trend and sum of all the shocks e. This formulation facilitates decomposition of the deviation of t t inflation from its deterministic trend into the sum of contributions from various shocks. 18Chapter II Prices and Costs in mobile tariffs. The increase in the contribution of CPI Food Group perishable items (non-durable with a 7-day recall7), Food and beverages (weight of 45.9 per cent in the which include vegetables, spices, fruits and other CPI basket) inflation exhibited distinct phases during food items such as milk, meat and fish and prepared the year so far. It averaged 8.0 per cent during April- meals, contributed to the stickiness in inflation June 2024, as weather disturbances such as heatwave in Q1. The contribution of semi-perishables (non- conditions and uneven rainfall distribution, as well as durable goods with a 30-day recall) to overall inflation tight supply conditions led to inflationary pressures in remained broadly unchanged with cereals, pulses, and vegetables, cereals, and pulses. There was, however, a personal care items being the main inflation drivers. sharp moderation in food inflation to 5.1 per cent in The contribution of durable items (goods with a 365- July 2024, as favourable base effects more than offset day recall) to overall inflation edged up during April- a significant pickup in momentum. In August, despite August 2024, primarily reflecting the uptick in gold a decline in food price momentum, food inflation prices. increased to 5.3 per cent due to unfavourable base The contribution of imported components8 to effects (Chart II.8). headline inflation turned positive from April 2024 and increased gradually to 0.5 percentage points by The food price build-up during 2024-25 so far (up to August 2024, driven by higher gold and silver prices August) has been substantial, although lower than (Chart II.7c). last year and the long-term historical average. High Chart II.8 CPI Food Inflation *: Includes meat & fish, egg, milk and pulses. **: Includes fruits, sugar, non-alocoholic beverages and prepared meals. Note: Figures in parentheses indicate weights in CPI food and beverages. Sources: NSO; and RBI staff estimates. 7 The CPI weighting diagrams use the modified mixed reference period (MMRP) data based on the 2011-12 Consumer Expenditure Survey conducted by the National Sample Survey Office (NSSO). Under MMRP, data are collected on expenditure incurred during the last seven days for frequently purchased items like edible oil, eggs, fish, meat, vegetables, fruits, spices, beverages, processed foods, pan, tobacco and intoxicants; expenditure incurred during the last 365 days for items like clothing, bedding, footwear, education, medical (institutional), durable goods; and expenditure incurred in the last 30 days for all other food, fuel and light, miscellaneous goods and services including non-institutional medical services, rents and taxes. 8 Global commodities that drive domestic prices include petroleum products; coal; electronic goods; gold; silver; chemical products; metal products; textiles; cereals; milk products, and vegetables oils – these together have a weight of 36.4 per cent in the CPI basket. 1199Monetary Policy Report October 2024 Chart II.9: Financial Year Price Build-up Chart II.10: Cereals Inflation (y-o-y) (August 2024 over March 2024) Note: Figures in parentheses indicate weights in CPI - food and beverages. Sources: NSO; and RBI staff estimates. Sources: NSO; and RBI staff estimates. vegetable prices contributed a disproportionately ban on exports of non-basmati white rice subject to large share to this build-up for the second successive a minimum export price (MEP) of $490/tonne, while year in a row (Chart II.9). removing the MEP on Basmati rice in September 2024 to support farmers’ price realisation. Wheat inflation, Cereals (weight of 9.7 per cent in the CPI and 21.1 on the other hand, was moderating till February 2024, per cent in the food and beverages group) inflation but it hardened thereafter to reach 6.6 per cent in remained elevated at an average of 8.3 per cent during August, reflecting lower buffer stocks (0.9 times the April-August 2024 (Chart II.10). Within cereals, rice norm as of September 16, 2024) and lower mandi inflation remained in double digits, despite export arrivals than in 2023-24. Wheat inflation was elevated restrictions, reflecting tight supply conditions due despite higher production and price stabilisation to lower rabi and summer production [(-)2.4 per cent measures, including the imposition of stock limits year-on-year (y-o-y) in 2023-24]. For effective supply for traders/wholesalers and retailers till March 2025, management and price stabilisation, government the likely offloading of stocks under the OMSS and has announced several measures including the retail continued restrictions on wheat exports. sale of ‘Bharat Rice’ and allowing rice-deficient states Vegetables (weight of 6.0 per cent in the CPI and 13.2 to directly purchase rice from the Food Corporation per cent in the food and beverages group) inflation of India at a fixed price of ₹2800/quintal under the remained elevated till June 2024, but witnessed a sharp Open Market Sale Scheme (OMSS) from August correction in July primarily because of favourable base 2024. The buffer stocks of rice (3.0 times the norm effect (Chart II.11). The price momentum, however, as of September 16, 2024) are comfortable and kharif remained firm in July, reflecting lower production sowing has been higher by 2.5 per cent in 2024-25 as [(-)3.2 per cent in 2023-24 over 2022-23 as per 3rd advance on September 27, 2024 compared to the corresponding estimates (AE) 2023-24] and supply disruptions due to period of last year, which are likely to improve supply heatwave conditions in parts of northern India, excess conditions and contain price pressures. With signs of rains in parts of central and southern India and the easing of supply conditions, government has lifted the resultant lower market arrivals. As supplies resumed, 20Chapter II Prices and Costs producing states of Uttar Pradesh, West Bengal, Chart II.11: Drivers of Vegetables Inflation (y-o-y) and Bihar. Onion prices moderated during January- February 2024, but started rising again, recording a y-o-y inflation of 60.6 per cent in July 2024 and 54.1 per cent in August due to deficient production [(-)19.7 per cent in 2023-24 over 2022-23 as per 3rd AE 2023-24]. For effective supply management, onion exports were allowed and 40 per cent export duty with a MEP of $550 per metric tonne was imposed in May 2024. Subsequently, in September 2024, the export duty was reduced to 20 per cent, and MEP was removed, allowing free shipments of onion. Tomato price increase, which averaged around 37 per cent during December 2023-June 2024 on a y-o-y basis, Note: Figures in parentheses indicate items' weights in CPI-vegetables. was on account of tight supply conditions induced Sources: NSO; and RBI staff estimates. by heatwaves and unseasonal rainfall. Prices declined vegetable prices declined in August, particularly from by (-)43.0 per cent, on a y-o-y basis, in July 2024 as a strong favourable base effect outweighed the a sharp correction in tomato prices. substantial increase in price momentum. Softening Among key vegetables, potato prices, on a y-o-y basis, in prices in August further pulled down tomato increased sequentially in 2024, reaching 65 per cent inflation to (-)47.9 per cent. Vegetables excluding TOP in July-August, driven by production shortfalls [(-)5.1 (tomato; onion; and potato), particularly garlic, also per cent in 2023-24 over 2022-23 as per 3rd AE 2023- witnessed considerable price build-up in Q1:2024- 24] due to unseasonal rains and prolonged spells of 25, emerging as another major driver of vegetables fog and cold conditions during winter in the major inflation (Chart II.12). Chart II.12: Price build-up in CPI Vegetables *: TOP denotes tomato, onion and potato. Sources: NSO; and RBI staff estimates. 2211Monetary Policy Report October 2024 Inflation in fruits (weight of 2.9 per cent in the CPI supply conditions through imposition of stock limits and 6.3 per cent within the food and beverages group) on tur and gram (till September 30, 2024), extension eased in July on a strong favourable base effect, of free import policy for yellow peas (till December 31, after rising during April-June 2024 to 6.3 per cent on 2024), and tur and urad (till March 31, 2025), weekly average. In August, it rose to 6.5 per cent despite higher stock disclosure requirements for five major pulses, production (2.3 per cent in 2023-24 over 2022-23 as per and sale of chana dal under the brand ‘Bharat Dal’. As the 3rd AE), with price increases primarily driven by a result, the stock-to-use ratio improved to 6.8 per cent bananas, apples and mangoes. Inflation in groundnut during April-August 2024 from 6.5 per cent during the prices, however, moderated from around 10.4 per cent corresponding period of 2023 (Chart II.14). in December 2023 to 1.7 per cent in July 2024 before Animal-based protein items exhibited high and volatile falling into the deflationary zone at (-)1.5 per cent in inflation movements during April-August 2024. August 2024, on account of higher kharif production Inflation in prices of meat and fish (weight of 3.6 per (1.1 per cent in 2023-24). cent in the CPI and 7.9 per cent in the food and beverages Pulses, the primary source of plant-based protein group) averaged 6.2 per cent during April-August 2024. (weight of 2.4 per cent in the CPI and 5.2 per cent in Inflation in the price of eggs (weight of 0.43 per cent the food and beverages group), continued to record in the CPI and 0.9 per cent in the food and beverages double-digit inflation due to deficient kharif and rabi group) exhibited considerable volatility, falling from production [(-)7.0 per cent in 2023-24 over 2022-23] on 10.3 per cent in March to 4.1 per cent in June before top of a decline in production in 2022-23. Within pulses, increasing to 7.1 per cent in August. Inflation in milk lower production of gram [(-)10 per cent in 2023-24], and products (weight of 6.6 per cent in the CPI and urad [(-)11.9 per cent] and moong [(-)15.6 per cent] as 14.4 per cent within the food and beverages group) well as subdued production in tur (3.2 per cent increase has remained range bound at around 3 per cent during in 2023-24 over 2022-23 against 21.5 per cent decline in April-August. Although milk price hikes by several 2022-23) were the primary drivers of price pressures cooperatives, including Amul and Mother Dairy, in (Chart II.13). Inflation in pulses prices moderated to June 2024 led to higher price momentum in June, it 13.6 per cent in August 2024 on interventions to ease was offset by favourable base effects (Chart II.15). Chart II.13: CPI Pulses and Products Chart II.14: Pulses Inflation and (Cumulative Financial Year Price Build-up) Stock-Use Ratio Sources: NSO; and RBI staff estimates. Sources: MOSPI; DGCI&S; CACP; Ministry of Agriculture; and RBI staff estimates. 22Chapter II Prices and Costs Chart II.15: Drivers of Animal Protein Inflation Chart II.16: Edible Oil Prices: Domestic and Global (H1:2024-25 over H2:2023-24) CPI oils and fats Global oils and meals (right scale) Note: Figures in parentheses indicate weights in CPI-animal protein group. Global palm oil (right scale) H1: 2024-25 refers to April-August. Sources: NSO; and RBI staff estimates. Sources: World Bank Pink Sheet; NSO; and RBI staff estimates. Prices of oils and fats (weight of 3.6 per cent in the CPI 25 compared to H2:2023-24 despite lower sugarcane and 7.8 per cent within the food and beverages group) production [(-)7.6 per cent in 2023-24 over 2022-23]. remained in deflation during April-August 2024 on Measures to augment domestic availability of higher imports and lower international prices of major sugar include extension of export restrictions, and edible oils (Chart II.16). The pace of deflation, however, imposition of 50 per cent export duty on molasses moderated, with continued positive momentum used for ethanol production as well as restriction reflecting pick-up in international edible oil prices as on the use of sugarcane juice and syrup for ethanol well as lower domestic production of oilseeds in the production since December 2023. The restrictions on sugar diversion for ethanol production were, however, 2023-24 season [(-)4.1 per cent in 2023-24 over 2022- eased in August 2024. 23]. The current kharif season sowing of oilseeds has been encouraging, particularly for groundnut. Among other food items, inflation in spices moderated In January 2024, the regime of lower import duties on a sustained basis since April 2024 and slipped on crude palm, sunflower and soyabean oil were into deflation since July after recording double-digit extended till March 2025. To improve domestic price inflation for a 22-month period till March 2024. The realisation, however, the import duty on crude and recent decline was led by jeera and dry chillies, on refined edible oils has been hiked by 20 percentage account of higher spices production (5.5 per cent as points in September 2024. Among other items in the per 3rd AE in 2023-24 over 2022-23). Inflation in prices oils and fats sub-group, inflation in ghee and butter of prepared meals has moderated gradually, reflecting prices continued to moderate. the pass-through of lower input costs. Retail Margins Inflation in prices of sugar and confectionery (weight of 1.4 per cent in the CPI and 3.0 per cent in the Retail price margins – the difference between retail food and beverages group) has moderated in 2024- and wholesale prices9 – in the case of cereals edged 2233 tnec rep ,y-o-Y tnec rep ,y-o-Y 10 40 5 20 0 0 -5 -20 -10 -40 -15 -60 -20 -80 22-guA 22-tcO 22-ceD 32-beF 32-rpA 32-nuJ 32-guA 32-tcO 32-ceD 42-beF 42-rpA 42-nuJ 42-guA 9 Item level retail and wholesale prices are aggregated at respective subgroups using item level CPI weights. Data for January-March 2021 have been excluded due to changes in price collection mechanism and item varieties by DCA.Monetary Policy Report October 2024 Chart II.17: Retail, Wholesale Prices and Margin Sources: Department of Consumer Affairs, Ministry of Consumer Affairs, Food and Public Distribution; and RBI staff estimates. up during March-May 2024 and thereafter started Chart II.18: CPI Food Inflation (y-o-y): to decline from June 2024 onwards to ₹4.3 per kg, Urban and Rural the lowest since December 2020. After recording a sustained increase between September 2023 and January 2024, pulses price margins witnessed a sustained decrease during February-September 2024. Retail price margins in edible oils continued to soften since June 2024, primarily due to the moderation in the margin of refined oils. Retail price margins of TOP vegetables started firming up from March 2024 onwards (Chart II.17). Sectoral and Spatial Distribution of Food Inflation Heightened CPI food inflation pressures were seen across both rural and urban areas, with average rural food inflation during April to August 2024 outpacing its urban counterpart (Chart II.18). Sources: NSO; and RBI staff estimates. 24Chapter II Prices and Costs CPI Fuel Group Table II.1: Distribution of food inflation across States/UTs: Number of states# The deflation in fuel prices deepened from (-)0.8 per 2023-24 2024-25 cent in February 2024 to (-)5.3 per cent in August Food Inflation Range (Apr-Aug) (Apr-Aug) 2024, reflecting the cumulative impact of the LPG Less than 2 per cent 1 1 Between 2 to 4 per cent 8 2 price reduction in August 2023 and March 2024. Between 4 to 6 per cent 11 13 Fuel deflation was also aided by softening of price Greater than 6 per cent 16 20 pressures, on a y-o-y basis, in kerosene, reflecing # Accounted for the unification of Daman and Diu with Dadra & Nagar Haveli and the formation of Ladakh as a Union Territory (UT). the pass-through of lower international prices, Sources: NSO; and RBI staff estimates. as well as in firewood and chips, and dung cake. Spatially, food inflation pressures have heightened – Electricity prices also moderated sharply from a the number of states/UTs with food inflation higher record high of 13.5 per cent in August 2023, on a than 6.0 per cent in the period April-August 2024 has increased to 20 vis-à-vis 16 in the corresponding y-o-y basis, to 4.8-4.9 per cent in July-August 2024 period a year ago (Table II.1). (Chart II.19). Chart II.19: CPI Fuel Group Inflation Notes: (1) The international price for LPG is based on spot prices for Saudi Butane and Propane, combined in the ratio of 60:40, respectively. These international product prices are indicative import prices. Further details are available at www.ppac.org.in. (2) The indicative international price for kerosene is the Singapore Jet Kero spot price. (3) The domestic prices of LPG and kerosene represent the average prices of four and three metros, respectively, as reported by Indian Oil Corporation Limited (IOCL). (4) Figures in parentheses indicate items' weights in CPI-fuel group. Sources: NSO; Bloomberg; IOCL; and RBI staff estimates. 2255Monetary Policy Report October 2024 Core CPI (CPI excluding Food and Fuel Groups) Table II.2: Exclusion-based Measures of Inflation (y-o-y) Core (CPI excluding food and fuel) disinflation continued during H1 of 2024-25 (April-August) as Period CPI excluding CPI excluding CPI excluding food food and fuel food fuel petrol fuel petrol diesel it softened to 3.1 per cent by May-June 2024. This (47.3) diesel (45.0) gold silver (43.8) sustained sequential softening observed for more Aug-23 4.9 5.1 4.8 than a year (since June 2023) was disrupted in July- Sep-23 4.5 4.7 4.4 August 2024 with core inflation averaging 3.4 per Oct-23 4.2 4.4 4.1 Nov-23 4.1 4.2 3.9 cent, primarily reflecting the impact of mobile tariff Dec-23 3.8 3.9 3.6 revisions. Exclusion-based measures of underlying Jan-24 3.5 3.7 3.4 inflation, which remove volatile items such as petrol, Feb-24 3.4 3.5 3.3 diesel, gold, and silver in addition to food and fuel, Mar-24 3.3 3.4 3.2 also witnessed similar movements during this period Apr-24 3.2 3.4 3.0 (Chart II.20 and Table II.2). May-24 3.1 3.3 2.8 Jun-24 3.1 3.3 2.8 While diffusion index for CPI excluding food, fuel, Jul-24 3.4 3.6 3.1 petrol, diesel, gold and silver indicated positive Aug-24 3.3 3.5 3.0 price increases across much of its consitutents, a Notes: (1) Figures in parentheses indicate weights in CPI. vast majority of these price increases were less than (2) Derived as residual from headline CPI. Sources: NSO; and RBI staff estimates. 6 per cent (m-o-m saar) and 4 per cent (m-o-m saar), (April-August) with contribution from all sub-groups/ as indicated by the steep fall in threshold DIs to well groups (Chart II.22). below the 50 level mark. Threshold DIs for CPI core, however, exhibited a sustained pick-up during June- Out of the 2.9 percentage points moderation in core August 2024, indicating a likely bottoming out of inflation from its peak in January 2023 till August 2024, muted price momentum (Chart II.21). around 90 bps was contributed by the clothing and Both core goods and services experienced significant footwear sub-group. In addition, housing accounted easing of inflationary pressures in 2024-25 so far for 42 bps, while household goods and services, and Chart II.20: CPI Inflation excluding Food and Chart II.21: CPI excluding Food, Fuel, Petrol, Fuel: Persistence Diesel, Gold and Silver: Diffusion Indices by Thresholds (M-o-M Seasonally Adjusted) Sources: NSO; and RBI staff estimates. Sources: NSO; and RBI staff estimates. 26Chapter II Prices and Costs Chart II.22: Contribution to CPI Inflation Chart II.23: Decline in CPI Core Inflation excluding Food Fuel (Percentage points) (Aug-24 over Jan-23): Contributions * Others include Pan, tobacco and intoxicants; and Recreation and amusement. * Others include Pan, tobacco and intoxicants, and discrepancies. Note: Figures in parentheses indicate weights in CPI excluding food and fuel. Sources: NSO; and RBI Staff estimates. Sources: NSO; and RBI Staff estimates. transport and communication contributed 38 bps and CPI) and services (weight of 23.0 per cent) components 33 bps, respectively (Chart II.23). shows a sequential softening of around 65 bps in core goods from 3.5 per cent in February 2024 to 2.9 per Decomposing core inflation – CPI excluding food, cent in August. The key drivers of this softening were fuel, petrol, diesel, gold, and silver inflation – into its clothing and footwear, transport and communication, goods (with a weight of 20.7 per cent in the headline household goods, and health items (Chart II.24a). Chart II.24: Contributions to CPI Inflation excluding Food, Fuel, Petrol, Diesel, Gold, and Silver * Represent balancing item to reconcile divergence in CPI index between CPI items indices aggregated vertically, across items and the published sub-group/group/overall CPI index. Note: Figures in parentheses indicate weights in CPI. Sources: NSO; and RBI staff estimates. 2277Monetary Policy Report October 2024 Core services inflation, on the other hand, fell mobile operators resulting in a rise in prices of from 3.2 per cent in February 2024 to 2.6 per cent communication services (Chart II.24b). An analysis in May, primarily driven by housing (house rent), of the determinants of house rent inflation indicate transport (such as railway charges and porter fares), that demand and supply conditions and inflation and education (tuition fee and other educational expectations have a significant role in shaping house expenses) services. It rose to 3.3 per cent during rent inflation (Box II.I). July-August due to tariff hikes across major private Box II.1: What Drives Housing (Rent) Inflation in India? CPI housing (rent10) inflation (y-o-y) has moderated from the Reserve Bank’s Inflation Expectations Survey of sequentially during March-August 2024 (Chart II.1.1). Households – has a positive and statistically significant An analysis of the determinants of housing (rent) inflation impact on CPI housing (rent) inflation. Demand conditions (seasonally adjusted annualised quarter-on-quarter rate, represented by the unemployment rate (UMP) from ΔHR) in an autoregressive distributed lag (ARDL) model the Periodic Labour Force Surveys11 (proxying aggregate reveals that inflation expectations – i.e., one-year ahead demand) and the night light index12 gap variable (NLG)13 inflation expectations of Indian (urban) households (proxying housing demand) – were also seen to have a Chart II.1.1: Evolution of CPI Housing (Rent) Inflation (y-o-y) Note: Sub-groups weights are displayed in brackets. The yellow shaded area represents the period of the 7th Central Pay Commission (CPC), and the blue shaded area represents the onset of the COVID-19 pandemic. Sources: NSO; and RBI staff estimates. (Contd.) 10 Housing is a major component in the CPI basket with a weight of 10.07 per cent, with house rent contributing 9.51 per cent and other housing services 0.56 per cent. Housing has a weight of 21.3 per cent in the CPI excluding food and fuel (core). The National Statistics Office (NSO) compiles the housing index for urban areas, considering both rented and self-owned dwellings. The NSO uses a rental equivalent approach for self-owned properties, applying market rent rates for similar rented homes. Actual rents are collected for private rentals, while government accommodation rents include the license fee and HRA foregone, adjusted by the occupant rank. 11 Sourced from Ministry of Statistics and Programme Implementation, Government of India. 12 Sourced from Indian Space Research Organisation (ISRO) Annual Night Light dataset. This has been interpolated to quarterly frequency using Denton- Cholette method with output gap as the proxy variable. 13 Night light gap (NLG) has been estimated as the gap between the night light index and its trend, using the Hodrick-Prescott filter. 28Chapter II Prices and Costs Table II.1.1: Determinants of Housing (Rent) Inflation Dep: Δ HR (1) (2) (3) (4) Δ HR (-1) 0.10** 0.10** 0.09** 0.09** (0.00) (0.00) (0.00) (0.00) IE (-1) 0.13* 0.14* 0.12* 0.13* (0.08) (0.07) (0.06) (0.06) UMP (-1) -0.12** -0.11** (0.00) (0.01) NLG (-1) 0.06** 0.06* (0.04) (0.08) Δ NLT (-1) -0.24** -0.23** -0.24** -0.24** (0.00) (0.00) (0.00) (0.00) ΔHP (-1) # 0.06 0.05 (0.13) (0.23) 7CPC 0.16** 0.15** 0.16** 0.16** (0.00) (0.00) (0.00) (0.01) Constant 4.85** 3.63** 4.68** 3.56** (0.00) (0.00) (0.00) (0.00) R-squared 0.682 0.680 0.685 0.680 LM test for autocorrelation (p-value) 0.131 0.159 0.075 0.054 ARCH LM test (p-value) 0.991 0.876 0.812 0.645 #Similar results were obtained on using the quarterly House Price Index published by RBI, instead of NHB-RESIDEX. Notes: 1. Figures in parentheses indicate p-values. ** and * indicate significance at 5 and 10 per cent levels, resepectively. 2. Inflation (y-o-y) is calculated after obtaining quarterly averages of monthly CPI Housing indices. 3. The variable 7CPC represents an interactive dummy to capture the HRA adjustments linked to the 7th Central Pay Commission. Source: RBI Staff Estimates. positive and significant influence, suggesting that the prices, on the other hand, are also found to be affected by shock to demand conditions induced by the onset of the aggregate and housing demand, inflation expectations as pandemic has had an impact on house rentals. An increase well as housing supply, i.e., the same covariates explain in housing supply, measured by changes in the trend of housing prices and rent. the night light index (NLT), is seen to have a negative References: effect on housing rent inflation (Table II.1.1). The changes in housing price (ΔHP) as measured using Mohan, R., Hasan, S., Roy, S., and Sarkar, S. (2024). RESIDEX14 from National Housing Bank (NHB) do not seem Deciphering the Drivers of CPI Housing Inflation in India. to have a significant impact on rent inflation. Housing mimeo. Trimmed mean measures15 also indicate an easing of 2024 reflecting the impact of higher food inflation, underlying inflation pressures since March 2024, with which has a relatively higher weight in CPI-AL and weighted median inflation moderating from 3.3 per CPI-RL. CPI inflation for industrial workers (CPI-IW), cent in March 2024 to 2.9 per cent in June (Table II.3). on the other hand, was below the headline CPI during Other Measures of Inflation the same period, primarily on account of double-digit CPI inflation for agricultural labourers (CPI-AL) and fuel deflation, despite higher food inflation in CPI- rural labourers (CPI-RL) were substantially higher IW vis-à-vis headline CPI. After remaining subdued than the CPI headline inflation during March-August till end of 2023-24, wholesale price index (WPI) 14 HPI@Assesment Prices accessible through https://residex.nhbonline.org.in/. 15 While exclusion-based measures drop a fixed set of volatile items (for example, food and fuel) in each period, trimmed measures exclude items located in the tails of the inflation distribution - items displaying changes more than the specified threshold in prices each month are excluded, and the items dropped differ from month to month. 2299Monetary Policy Report October 2024 of deflation. Thereafter, WPI inflation softened in Table II.3: Trimmed Mean Measures of Inflation (y-o-y) July, primarily due to favourable base effects. The softening continued in August on account of negative Month 5% 10% 25% Weighted trimmed trimmed trimmed Median price momentum mainly coming from the food group. Aug-23 5.7 5.6 5.3 5.2 With overall WPI recording sequential increase since Sep-23 4.7 5.0 4.9 4.7 April 2024, inflation measured by deflators for gross Oct-23 4.5 4.9 4.7 4.4 Nov-23 4.6 4.8 4.5 4.1 value added (GVA) and gross domestic product (GDP) Dec-23 4.8 4.7 4.2 4.1 hardened in Q1:2024-25 (Chart II.25a). Jan-24 4.7 4.5 3.9 3.7 Feb-24 4.6 4.4 3.7 3.6 Similar sub-groups/items across CPI and WPI Mar-24 4.7 4.4 3.6 3.3 exhibited varying inflation movements. While WPI Apr-24 4.6 4.2 3.5 3.0 inflation in major food sub-groups (particularly May-24 4.5 4.2 3.4 2.9 cereals, pulses, milk, sugar, fruits and spices) Jun-24 4.3 3.9 3.4 2.9 ruled above corresponding CPI groups/subgroups, Jul-24 3.8 3.7 3.3 3.0 Aug-24 3.9 3.7 3.3 3.0 inflation in vegetables and egg prices, and clothing Sources: NSO; and RBI staff estimates. and footwear was higher in the CPI than in the WPI. inflation picked up during April-June 2024 with food Similarly, deflation in petrol was lower in the WPI inflation registering a sharp uptick along with fuel vis-à-vis CPI, while the same was higher for diesel in and non-food manufactured products moving out the former (Chart II.25b). Chart II.25: Alternative Measures of Inflation Note: For Q1:2024-25, implicit GDP and GVA deflators are used. Sources: NSO; Labour Bureau; Ministry of Commerce and Industry; and RBI staff estimates. 30Chapter II Prices and Costs II.3 Costs Chart II.26: Farm and Non-farm Input Cost Costs, as measured by WPI inflation in industrial raw Inflation (y-o-y) materials and farm inputs, remained subdued during April-August 2024. While the prices of farm inputs remained in deflation, those of industrial inputs entered positive territory in June 2024, but turned negative again in August, mirroring movements in international commodity prices (Chart II.26). Prices of industrial inputs such as high-speed diesel (HSD), bitumen and petroleum coke were mostly in deflation during April-August 2024. The other contributory factors were non-food articles, particularly raw cotton and oilseeds, whose prices also recorded deflation during this period. Minerals price inflation, however, remained positive during *: Comprise primary non-food articles, minerals, coal, aviation turbine fuel, high April-August 2024, primarily driven by iron ore, speed diesel, naphtha, bitumen, furnace oil, lube oil, petroleum coke, electricity, due to increased global demand. Farm input prices cotton yarn and paper and pulp from WPI. $: Comprise high speed diesel, fodder, electricity, fertilisers, pesticides, and remained in deflation, driven by those of high-speed agricultural and forestry machinery from WPI. Sources: Ministry of Commerce and Industry; and RBI staff estimates. diesel (HSD), electricity, and fodder and pesticides. (Chart II.27). On a month-on-month basis, however, Moving from input costs to wage costs, nominal both agricultural and non-agricultural wages rural wage growth (y-o-y) decelerated to 4.9 per cent in July 2024 from 5.7 per cent in March 2024 driven sustained a steady growth of around 0.45 per cent and by both non-agricultural and agricultural occupations 0.4 per cent during the same period, respectively. The Chart II.27: Wage Growth (y-o-y) and Inflation in Rural Areas (y-o-y) *: Comprise ploughing, sowing, harvesting, picking, horticulture workers, fishermen, loggers and wood cutters, animal husbandry, packaging, general agriculture labourers, plant protection workers. **: Comprise carpenter, blacksmith, mason, weavers, beedi makers, bamboo-cane basket weavers, handicraft workers, plumbers, electrician, construction workers, LMV & tractor drivers, sweeping/cleaning workers, and other non-agricultural labourers. Sources: NSO; Labour Bureau; and RBI staff estimates. 3311Monetary Policy Report October 2024 month-on-month increase in agricultural wage was prices are expected to soften across manufaturing, mainly driven by ploughing/tilling workers, followed services and infrastructure sectors in Q3:2024-25. by loggers and woodcutters, plant protection workers, The pace of salary outgo is expected to moderate for and general agricultural labourers, while the increase services and infrastructure in Q3:2024-25 while it is in non-agricultural wages was on account of masons, anticipated to rise for manufacturing (Chart II.29). electricians, and light motor vehicle and tractor One year ahead business inflation expectations17 drivers in the rural sector. Despite the deceleration declined to 4.05 per cent in August 2024 from in nominal rural wages, real rural wages (deflated 4.21 per cent in the previous month on account of using CPI rural inflation) recorded a marginal growth moderation in cost pressures with ‘somewhat less of 0.8 per cent in July from 0.2 per cent in March than normal’ or lower sales and subdued profit 2024, primarily reflecting the sharp fall in CPI rural margin expectations. inflation in July. As per the purchasing managers’ index (PMI), In the organised sector, staff cost growth (y-o-y) manufacturing firms, which had been reporting decelerated for manufacturing firms among listed increasing input price pressures since March 2024, companies in Q1:2024-25, while it remained steady pointed to a moderation in the rate of input cost for services firms. The share of staff cost in the expansion during August-September 2024. In tandem value of production increased for manufacturing but with input prices, pace of output price increases stayed stable for services in Q1 (Chart II.28). across manufacturing also rose before decelerating Firms polled in the Reserve Bank’s enterprise in September 2024. This turned the input-output surveys16 indicate that in Q3:2024-25, the cost of price gap for manufacturers marginally positive inputs are expected to soften for manufacturing in September 2024. In case of services sector, the while remaining elevated for services and rate of expansion in input costs remained elevated infrastructure sectors. On the other hand, selling during March-May 2024, before it saw a softening Chart II.28: Staff Cost in Manufacturing and Services Sources: Capitaline database; and RBI staff estimates. 16 Industrial Outlook Survey; and Services and Infrastructure Outlook Survey. 17 Based on the monthly Business Inflation Expectations Survey (BIES) of the Indian Institute of Management, Ahmedabad. The survey polls a panel of business leaders primarily from the manufacturing sector about their inflation expectations in the short and medium term. 32 tnec reP tnec reP a: Manufacturing Sector Base Effect Staff cost growth (y-o-y) Quarterly Momemtum Staff cost/value of production (right scale) tnec reP tnec reP b: Services Sector 14 5.7 6 12 10 5 10.3 8 6 4 4 2 3 0 -2 -4 2 -6 -8 1 22-12-4Q 32-22-1Q 32-22-2Q 32-22-3Q 32-22-4Q 42-32-1Q 42-32-2Q 42-32-3Q 42-32-4Q 52-42-1Q 30 40 25 35 20 27.8 30 15 25 10 8.7 20 5 15 0 10 -5 -10 5 -15 0 22-12-4Q 32-22-1Q 32-22-2Q 32-22-3Q 32-22-4Q 42-32-1Q 42-32-2Q 42-32-3Q 42-32-4Q 52-42-1QChapter II Prices and Costs Chart II.29: Expectations of Cost and Price Conditions Note: ‘Net response’ is the difference between the percentage of respondents reporting an increase in prices and those reporting decrease. Sources: Reserve Bank’s Industrial Outlook Survey; Services & Infrastructure Outlook survey; and RBI staff estimates. during June-September. The prices charged across rising labour and material costs. Subsequently, with services firms, which had been lagging behind input cost pressures moderating, the rate of expansion in price increases during March-June 2024, quickened prices charged receded in August-September 2024 in July 2024 on the back of pent up pass-through of (Chart II.30). Chart II.30: PMI Input-Output Price Gap Sources: S&P Global; and RBI staff estimates. 3333Monetary Policy Report October 2024 II.4 Conclusion muted with the continuing impact of disinflationary monetary policy stance and softening bias in The disinflation process in H1 of 2024-25 so far (April- international commodity prices. Recent pickup in August) has been characterised by interruptions on global metals and crude oil prices and uncertainties account of persistent food inflation pressures from on account of geopolitical developments need to be adverse weather events, despite steady softening of monitored. In the context of the apparent rigidities core inflation. Food inflation could see an easing in to the last mile of disinflation in the recent period, a H2 of 2024-25, benefiting from normal monsoons steadfast commitment to alignment of inflation with and improvements in agricultural output on the back the target is imperative to preserve and build upon of a likely good kharif production and healthy rabi the credibility gains in monetary policy achieved sowing, although occurrences of adverse weather during the pre- and post-COVID flexible inflating events and recent uptick in global food prices, if targeting (FIT) period. A durable low inflation sustained, could impinge upon the food inflation environment will strengthen the foundations of a outlook. Core inflation pressures have remained sustained high growth trajectory. 34Chapter III Demand and Output III. Demand and Output Domestic economic activity in H1:2024-25 was supported by a strong performance from the two main drivers of aggregate demand – private consumption and investment activity. Improved agriculture prospects, sustained buoyancy in services, consumer and business optimism, government’s continued thrust on capex, and healthy balance sheets of banks and corporates brighten the outlook. Geopolitical tensions, geoeconomic fragmentation, unseasonal rains and weather disturbances, and volatility in financial markets pose downside risks. Domestic economic activity remained resilient in from 7.8 per cent in the previous quarter (Table III.1 H1:2024-25. Private consumption rebounded, driven and Chart III.1). The momentum of GDP – quarter-on- by the turnaround in rural demand and sustained quarter (q-o-q) seasonally adjusted annualised growth urban demand. Investment activity held firm despite rate (saar) – slowed down in relation to the previous lower government capex. Government consumption quarter (Chart III.1b). contracted (year-on-year, y-o-y) during Q1:2024-25. GDP Projections versus Actual Outcomes On the supply side, industry and services remained buoyant with construction, education, health and The Monetary Policy Report (MPR) of April 2024 other services supporting growth. had projected real GDP growth at 7.1 per cent for III.1 Aggregate Demand Q1:2024-25. Actual growth turned out to be lower, mainly on account of lower government consumption Aggregate demand conditions witnessed some moderation as real gross domestic product (GDP) expenditure as election-related restrictions were in growth decelerated to 6.7 per cent (y-o-y) in Q1:2024-25 place (Chart III.2). Chart III.1: GDP Growth and its Constituents Note: saar – Seasonally adjusted annualised rate. Sources: National Statistical Office (NSO); and RBI staff estimates. 3355Monetary Policy Report October 2024 Table III.1: Real GDP Growth (y-o-y, per cent) Item 2022-23 2023-24 Weighted 2022-23 2023-24 2024-25 Contribution* (FRE) (PE) 2022-23 2023-24 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Private final consumption expenditure 6.8 4.0 3.9 2.3 18.5 8.2 1.8 1.5 5.5 2.6 4.0 4.0 7.4 Government final consumption expenditure 9.0 2.5 0.9 0.2 9.8 3.4 7.1 13.9 -0.1 14.0 -3.2 0.9 -0.2 Gross fixed capital formation 6.6 9.0 2.2 3.0 13.9 4.7 5.0 3.8 8.5 11.6 9.7 6.5 7.5 Exports 13.4 2.6 3.0 0.6 19.1 11.7 10.9 12.4 -6.6 5.0 3.4 8.1 8.7 Imports 10.6 10.9 2.5 2.7 26.1 16.1 4.1 -0.4 15.2 11.6 8.7 8.3 4.4 GDP at market prices 7.0 8.2 7.0 8.2 12.8 5.5 4.3 6.2 8.2 8.1 8.6 7.8 6.7 Notes: *: Component-wise contributions to growth do not add up to GDP growth because change in stocks, valuables and discrepancies are not included. FRE: First revised estimates; PE: Provisional estimates. Sources: NSO; and RBI staff estimates. III.1.1 Private Final Consumption Expenditure industrial production (IIP) for consumer durables was robust at 10.6 per cent in Q1:2024-25 and 8.2 Private final consumption expenditure (PFCE) – per cent in July 2024, indicating steady expansion in the mainstay of aggregate demand – rebounded discretionary spending in urban areas (Chart III.3). As strongly, growing at 7.4 per cent in Q1:2024-25 and per the latest round of the Reserve Bank’s consumer contributing 4.2 percentage points to overall GDP confidence survey, consumer confidence (current growth. Amongst the high frequency indicators (HFIs) situation index) improved in September 2024, along of urban consumption, domestic air passenger traffic with an improvement in households' optimism on one year ahead economic conditions. Bank credit rose by 5.6 per cent in Q1:2024-25 and sustained its to households grew in double digits, despite the momentum in July-August 2024. Passenger vehicle slowdown in unsecured personal loans and credit sales posted positive y-o-y growth in Q1:2024-25 cards outstanding that set in after the November 16, but contracted in July-August 2024. The index of 2023 measures (Chart III.3d). Rural demand is showing a gradual pickup. While Chart III.2: GDP Growth - Projection versus motorcycle sales continued to record upbeat growth Actual - Q1:2024-25 in April-August 2024, tractor sales expanded in June- July 2024 (Chart III.4). The demand for work under the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) contracted by 16.6 per cent in Q2:2024-25, reflecting an improvement in farm sector employment. Spending on fast moving consumer goods (FMCG) in the rural areas bodes well for rural demand. The positive outlook for agriculture, supported by above normal south-west monsoon (SWM) rainfall, higher cumulative kharif sowing and improved reservoir levels augurs well for sustaining the revival in rural demand. An examination of macroeconomic drivers of item Sources: NSO; and RBI staff estimates. group-wise consumption reveals that income effect 36Chapter III Demand and Output Chart III.3: Urban Demand: High-Frequency Indicators Sources: Directorate General of Civil Aviation (DGCA); Society of Indian Automobile Manufacturers (SIAM); NSO; and RBI. boosts consumption demand while economic discretionary items, they are more insulated from uncertainty dampens it. As consumption of necessary economic uncertainty (Box III.1). items have lower elasticity of substitution than Chart III.4: Rural Demand: High-Frequency Indicators Sources: Tractor and Mechanization Association (TMA); SIAM; NSO; and Ministry of Chemicals and Fertilisers. 3377Monetary Policy Report October 2024 Box III.1: Consumption Switching? Unravelling the Drivers behind Changing Consumption Patterns in India There has been a slowdown in private final consumption private consumption, I is the short-term interest proxied t expenditure (PFCE) in the post-pandemic period (average by weighted average call money rate, U is macroeconomic t growth rate of 5.4 per cent) when compared with the pre- uncertainty [proxied by the economic policy uncertainty COVID period1 (average growth of 6.7 per cent). PFCE grew (EPU) index by Bloom, Blake and Scott (2016)2] and gY by a meagre 4.0 per cent in 2023-24 as adverse rainfall is the q-o-q income growth (real GDP growth lagged by t–1 conditions weakened rural demand. Consumption, 1 quarter). The estimation period is Q1:2012-13 to however, rebounded with a 7.4 per cent growth in Q1:2024-25. The findings suggest that higher interest Q1:2024-25. Drawing on the real business cycle literature rates hurt consumption growth, and the effect increases (Kydland and Prescott, 1982), consumption switching is in the upper quantiles, i.e., when consumption growth is analysed at the aggregate level using a quantile regression high. The income effect improves consumption growth, framework, based on the following specification but the impact gradually moderates when consumption Q gC ατ ατ C ατI ατU ατgY η τ t t t t t growth is high. Economic uncertainty acts as a dampener Wh (ere) f=o r d0 i+ff e1regn–t1 +qu a2nt+il es3 (τ)+, gC4 ist –t1h +e q-o-q growth of of consumption growth across all quantiles (Chart III.1.1). t Chart III.1.1: Quantile Regression Coefficient Plot Notes: Bands around the point estimates are 95 per cent bootstrapped confidence intervals. X-axis denotes quantiles. (Contd.) 1 Pre-COVID period includes Q1:2012-13 to Q4:2019-20. 2 Robustness checks are carried out using the economic uncertainty index derived from SPF data by Patra et. al. (2023). Results are in similar lines. 38Chapter III Demand and Output Next, the precautionary motive is linked to consumption discretionary spending is expected to recover steadily as switching by looking at consumption growth at a broad income strengthens. A watchful monetary policy restricts commodity level. Following a nested Constant Elasticity the spillover of price pressure to discretionary spending, of Substitution (CES) approach (Fernandez-Villaverde facilitating a rebound of aggregate demand. and Guerron-Quintana, 2020), intra-temporal choices Table III.1.1: Dynamic Panel Estimates of Drivers of of households are governed by elasticity of substitution Consumption Growth among the necessary and discretionary group of PFCE PFCE PFCE PFCE commodities i.e. (1) (2) (3) (4) (for essentials) and PFCE(-1) -0.020* -0.020* -0.079* -0.079* (0.011) (0.012) (0.039) (0.041) δ -0.634** -0.634*** -0.674*** -0.674** (for discretionary) (0.257) (0.195) (0.256) (0.267) (𝜋𝑖 − 𝜋) × 1𝐷 Following this, the panel regression specification can be -0.251 -0.251 -0.124 -0.124 (0.161) (0.290) (0.163) (0.319) generalised as (𝜋𝑖 − 𝜋) × 1𝑁 Interest Rate (-1) 1 -1.286*** -1.286* -0.272 -0.272 D C j C j θ π j π θ X γ j (0.467) (762) (0.508) (580) t t N|D × Interest Rate (-1) 1 -0.076 -0.076 0.335 0.335 wh(e)r =e θC0 jt-1 (th)e+ co1n(sut (m)p –ti on) ×of 1 j-th + i te2m ti ×n 1cNo|nD +su mj+p ϵtti (on) N (0.608) (0.282) (0.645) (0.270) t × basket, is the indicator variable for necessary/ GDP (-1) 1 1.823*** 1.823*** (N)D D discretionary items3 within consumption basket. (0.238) (0.519) 1 | GDP (-1) × 1 1.059*** 1.059*** π π is the inflation differentials between item N t t (0.292) (0.407) g (ro u (p j) j – and ) headline inflation. X t are the controls for GNDI (-1)× 1 D 1.257*** 1.257*** macroeconomic conditions, which include GDP [or Gross (0.166) (0.299) × National Disposable Income (GNDI)] growth (lagged by GNDI (-1) 1 0.712*** 0.712* N (0.217) (0.364) one year), interest rate, and macroeconomic uncertainty. × Uncertainty 1 -0.025 -0.025** -0.037** -0.037*** γ is the commodity group fixed effects to absorb D j (0.019) (0.013) (0.018) (0.011) heterogeneity. × Uncertainty 1 -0.001 -0.001 -0.017 -0.017 N (0.026) (0.005) (0.026) (0.014) Using annual data for the period 2004-234 and group- × - Robust - Robust level inflation, the effects of the drivers are derived Standard errors in parentheses using dynamic panel estimates. The estimates show * p < 0.10, ** p < 0.05, *** p < 0.01 that the elasticity of substitution among the necessary References: items is lower than for discretionary items. The interest Baker, S. R., N. Bloom, and S. J. Davis (2016). Measuring rate adversely impacts the consumption of discretionary Economic Policy Uncertainty, Quarterly Journal of items. Income effects strengthen the consumption of all Economics, 131(4), 1593-1636. items, and the effect is marginally higher on discretionary Fernandez-Villaverde, Jesus and Pablo A. Guerron- consumption items. Policy uncertainty dampens Quintana (2020). Uncertainty Shocks and Business Cycle discretionary consumption demand (Table III.1.1). Research. Review of Economic Dynamics. 37, 118-146. Accommodative monetary policy helped offset the Kydland, F. E., and Prescott, E. C. (1982). Time to Build and adverse effects of higher economic uncertainty, which led Aggregate Fluctuations. Econometrica, 50(6), 1345–1370. to lower consumption of discretionary items in the post- Patra, M. D., Mohan R., John J., and Bhattacharya I. (2023). pandemic period, while essential spending remained Measuring Uncertainty: An Indian Perspective. RBI largely unaffected. With the ongoing economic recovery, Bulletin, October, 169-178. 3 Within broad commodity groups, the necessary items are food, clothing, medical and education. The rest, i.e., hotel, housing, furniture, transport, communication, recreation and miscellaneous items, are discretionary in spending type. 4 National accounts data of household consumption is available up to 2022-23. 3399Monetary Policy Report October 2024 Chart III.5: Employment Situation in India Sources: MoSPI; and Employees’ Provident Fund Organisation (EPFO). Employment conditions remained robust in Q1:2024- capital goods expanded strongly during April-August, 25, though labour force participation rate (LFPR) led by electronic goods, transport equipment and and employment rate (ER) under the Urban Periodic electrical and non-electrical machinery (Chart III.6a). Labour Force Survey (PLFS) moderated marginally Construction activity gathered momentum on the back relative to the previous quarter. However, both of an ebullient housing sector. Among the coincident indicators recorded the second highest reading since indicators of construction activity, steel consumption the survey’s inception. The unemployment rate in recorded double digit growth in April-August 2024, but urban areas declined during Q1 to 6.6 per cent, one cement production posted a modest expansion during of the lowest in the PLFS series (Chart III.5a). The April-August mainly due to the heat wave in April and Employees’ Provident Fund Organisation (EPFO) monsoon rains since June 2024 (Chart III.6c and d). payrolls data also point to strengthening of formal Capacity utilisation (CU) in the manufacturing sector5 employment as net payroll additions rose by 47.2 per recorded a seasonal dip to 74.0 per cent in Q1:2024-25 cent y-o-y in April-July 2024. The net payroll additions from 76.8 per cent in Q4:2023-24. Seasonally adjusted were higher than in previous years (Chart III.5b). capacity utilisation improved from 74.6 to 75.8 and III.1.2 Gross Fixed Capital Formation is well above the long-term average of 73.8 per cent6 Gross fixed capital formation (GFCF) expanded by (Chart III.7). Stretched capacity utilisation necessitates 7.5 per cent in Q1:2024-25 despite contraction in new capacity additions to keep pace with underlying government capex, reflecting robust private sector domestic demand. Funds raised for capex by private investment. The share of GFCF in GDP at 34.8 corporates during Q1:2024-25 through the different per cent in Q1, is the highest since Q2:2012-13. channels (banks/FIs, ECBs, IPOs) remained strong, Amongst the key underlying indicators, import of indicating upbeat investment sentiment. 5 Based on RBI’s survey of order books, inventories and capacity utilisation. 6 Long term average is for the period Q1:2008-09 to Q1:2024-25 excluding Q1:2020-21. 40Chapter III Demand and Output Chart III.6: Indicators of Investment Demand Sources: Directorate General of Intelligence & Statistics (DGCI&S); NSO; Joint Plant Committee; and Office of Economic Adviser. The interest coverage ratio (ICR)7 of listed private Within the services sector, the ICR of IT companies manufacturing companies improved in Q1:2024-25, remained stable while that of non-IT companies indicating comfortable debt servicing capacity and stayed above the threshold level of unity (Chart III.8). conducive conditions for expansion in capacity. Chart III.7: Capacity Utilisation in Manufacturing Chart III.8: Interest Coverage Ratio Note: Data for Q1:2024-25 are based on results of 2,934 listed non-government non-financial companies. Source: RBI staff estimates. Source: RBI staff estimates. 7 Interest coverage ratio is the ratio of earnings before interest and taxes (EBIT) to interest expenses and measures a company’s capacity to make interest payments on its debt. The minimum value for a viable ICR is 1. 4411Monetary Policy Report October 2024 Chart III.9: Centre’s Expenditure during April-August Sources: Controller General of Accounts (CGA); and RBI staff estimates. III.1.3 Government Consumption improve, with revenue expenditure to capital outlay ratio declining to an all-time low of 4.0. Moreover, Government final consumption expenditure (GFCE) capital expenditure is budgeted to increase to a two- contracted by 0.2 per cent (y-o-y) in Q1:2024-25, decade high of 3.4 per cent of GDP in 2024-25 from pulling down overall GDP growth (Table III.1). The 3.2 per cent in provisional actuals of 2023-24, which is Government of India’s (GoI) revenue expenditure expected to support growth during the year. excluding interest payments and major subsidies registered a modest increase of 3.1 per cent (y-o-y) On the receipts side, the central government’s gross during April-August 2024, whereas the capital tax revenues increased by a 12.1 per cent (y-o-y) expenditure contracted by 19.5 per cent during the during April-August 2024, driven by a rise in income same period8 (Chart III.9a). The revenue expenditure tax revenue. Indirect tax revenue expanded by 10.0 to capital outlay (RECO) ratio at 5.2 in April-August per cent (y-o-y), aided by goods and services tax (4.1 a year ago) suggests some moderation in (GST) collections (centre plus states) and customs expenditure quality during the period. However, duty collections. Overall, the robust tax collection revenue deficit as per cent of gross fiscal deficit is reflective of buoyant economy and effective improved to 32.9 during the period (44.2 per cent a enforcement by the tax authorities (Chart III.10). year ago) [Chart III.9b]. Custom duty receipts recorded a robust y-o-y increase of 12.9 per cent, whereas union excise duties grew The Union Budget for 2024-25 reiterated the by 4.2 per cent (y-o-y). Overall, net tax revenue of the commitment towards fiscal prudence by budgeting central government increased by 8.7 per cent during a gross fiscal deficit (GFD) of 4.9 per cent of GDP, a April-August 2024 (Table III.2). drop of 66 basis points from the provisional actuals of 2023-24. This is in line with the medium-term target Non-tax revenue receipts recorded a growth of 59.6 of achieving a GFD of less than 4.5 per cent of GDP per cent primarily on the back of a surplus transfer by 2025-26. The quality of expenditure is budgeted to of ₹2.1 lakh crore from the Reserve Bank, which was 8 There has been a turnaround in Q2:2024-25 (July-August), with GoI's revenue expenditure excluding interest payments and major subsidies, and capital expenditure expanding by 9.6 per cent and 25.8 per cent, respectively. 42Chapter III Demand and Output Table III.2: Central Government’s Tax Collections Item ₹ thousand crore Per cent BE Actuals Per cent to BE Growth Rate 2023-24 2024-25 Apr-Aug 2023 Apr-Aug 2024 Apr-Aug 2023 Apr-Aug 2024 Apr-Aug 2023 Apr-Aug 2024 A. Direct taxes 1,823.3 2,207.0 609.8 695.6 33.4 31.5 26.2 14.1 Of which 1. Corporation tax 922.7 1,020.0 238.9 224.6 25.9 22.0 15.1 -6.0 2. Income tax 873.0 1,150.0 360.4 452.3 41.3 39.3 35.7 25.5 B. Indirect taxes 1,537.6 1,633.2 579.4 637.1 37.7 39.0 7.8 10.0 Of which 1. Total GST 960.5 1,066.8 392.7 432.5 40.9 40.5 10.6 10.2 2. Custom duties 233.1 237.7 83.5 94.3 35.8 39.7 27.8 12.9 3. Union excise duties 339.0 324.0 99.8 104.0 29.4 32.1 -12.4 4.2 C. Gross tax revenue 3,360.9 3,840.2 1189.2 1332.7 35.4 34.7 16.5 12.1 D. Assignment to States/UTs 1,021.4 1,247.2 382.5 455.7 37.4 36.5 20.4 19.1 E. Net tax revenue 2,330.6 2,583.5 803.9 873.8 34.5 33.8 14.8 8.7 Note: BE: Budget Estimates. Sources: Union Budget Documents; and CGA. significantly higher than ₹87,416 crore transferred higher than 2.9 per cent in 2023-24 provisional last year (Chart III.11). Accordingly, the central accounts (PA). Growth in revenue receipts is budgeted government’s gross fiscal deficit (GFD) during April- to accelerate to 19.1 per cent. States’ capital spending August 2024 stood at 27.0 per cent of the budget is expected to rise by 21.0 per cent in 2024-25 on top estimates, substantially lower than a year ago. of 23.4 per cent growth a year ago. The revenue deficit The consolidated GFD of state governments is (RD) is expected to remain stable at 0.2 per cent of budgeted at 3.1 per cent of GDP in 2024-25, marginally GDP (Table III.3 and Chart III.12). Chart III.10: GST Collections (Centre plus States) Chart III.11: Non-tax Revenue - April-August Source: Ministry of Finance (MoF). Source: CGA. 4433Monetary Policy Report October 2024 Table III.3: State Government Finances - Key Chart III.12: Receipts and Expenditure of the Deficit Indicators States/UTs (Per cent to GDP) 2022-23 (A) 2023-24 (PA) 2024-25 (BE) Revenue Deficit 0.2 0.2 0.2 Gross Fiscal Deficit 2.7 2.9 3.1 Primary Deficit 1.0 1.4 1.4 Notes: A: Actuals; PA: Provisional Accounts; BE: Budget Estimates. Data pertain to 31 States/UTs. Sources: Budget Documents of State Governments; and Comptroller and Auditor General (CAG) of India. As per the data available for April-July 2024-25, states’ GFD increased due to higher revenue expenditure and a contraction in grants from the GoI (Chart III.13a). Both tax and non-tax revenues, however, recorded robust growth (Chart III.13b). Meanwhile, on a y-o-y basis, capital expenditure declined. The Union Budget Note: Data pertain to 31 states/UTs. Sources: Budget Documents of State Governments; and CAG. 2024-25 has made a provision of ₹1.5 lakh crore for long-term interest-free loans, which could assist States average yield of these issuances during this period in boosting their capital spending. was 7.0 per cent, marginally lower than 7.2 per cent recorded in the previous year, while the weighted The Union Budget for 2024-25 allocated gross and net average maturity elongated to 20.7 years, up from 17.6 market borrowings via dated securities amounting to ₹14.01 lakh crore and ₹11.63 lakh crore, respectively. years. During H2, the Centre has planned gross market In the first half of the fiscal year, the central borrowings through dated securities of ₹6.61 lakh government’s gross market borrowings amounted to crore. Concurrently, States raised ₹3.86 lakh crore in ₹7.40 lakh crore, accounting for 52.8 per cent of the gross market borrowings during H1:2024-25, against annual budget estimates (Table III.4). The weighted an indicative calendar amount of ₹5.18 lakh crore. Chart III.13: Key Fiscal Performance Indicators (April - July) Note: Data pertain to 25 States/UTs. Source: CAG. 44Chapter III Demand and Output Table III.4: Government Market Borrowings (₹ crore) 2022-23 2023-24 2024-25 (April to September 30) Centre States Total Centre States Total Centre States Total Net borrowings 11,08,261 5,18,830 16,27,091 11,80,456 7,17,140 18,97,596 5,74,399 2,63,271 8,37,670 Gross borrowings 14,21,000 7,58,392 21,79,392 15,43,000 10,07,058 25,50,058 7,39,697 3,85,637 11,25,334 Sources: Government of India; and RBI staff estimates. For Q3:2024-25, the indicative calendar has placed imports rose by 7.1 per cent (y-o-y) during this period. states’ gross market borrowings at ₹3.20 lakh crore. Consequently, the merchandise trade deficit widened To meet the transitory mismatches between receipts to US$ 116.7 billion from US$ 99.2 billion during and expenditures, the Ways and Means Advances the corresponding period a year ago (Chart III.14). (WMA) limit for the GoI was set at ₹1.5 lakh crore for As per the estimates released by the NSO, exports of goods and services increased by 8.7 per cent y-o-y in H1:2024-25; it has been fixed at ₹50,000 crore for H2. real terms in Q1:2024-25, and imports of goods and Taking into account the recent expenditure trends, services grew by 4.4 per cent. the WMA limits for States and Union Territories have been increased to ₹60,118 crore from the previous Merchandise exports growth, after experiencing limit of ₹47,010 crore, effective from July 1, 2024.9 a pickup in Q1:2024-25, contracted in Q2 (up to August). For H1:2024-25 (April-August), the growth III.1.4 External Demand in merchandise exports was mainly led by electronic India’s external demand revived in H1:2024-25 goods, engineering goods, drugs and pharmaceuticals, (April-August), buoyed by a recovery in global trade. readymade garments, and organic and inorganic Merchandise exports (US$) expanded by 1.1 per cent chemicals. On the other hand, petroleum products, (y-o-y) during April-August 2024, while merchandise gems and jewellery, rice, marine products, and iron ore dragged down exports (Chart III.15). Chart III.14: Merchandise Trade The expansion in merchandise imports in H1:2024- 25 (April-August) was driven by higher imports of petroleum, oil and lubricants (POL), gold and non- POL non-gold commodities such as electronic goods, transport equipment, and silver. Import of pearls, precious and semi-precious stones, chemical material and products, coal, coke and briquettes, fertilisers, and dyeing materials contributed negatively to the overall import growth (Chart III.16). POL imports grew by 9.2 per cent (y-o-y) to US$ 76.4 billion in H1 (April- August), while non-POL non-gold imports rose by 4.5 per cent (y-o-y) to US$ 196.2 billion during this period. Services exports remained buoyant, with a growth Source: DGCI&S. of 9.8 per cent y-o-y in Q1:2024-25 and 10.9 per 9 Based on the recommendations made by the Group constituted by the Reserve Bank and consisting of select State Finance Secretaries. 4455Monetary Policy Report October 2024 Chart III.15: Merchandise Exports Notes: Figures in parentheses in chart b are y-o-y per cent change in exports of the commodity during the period. RMG stands for readymade garments. Data on world trade is available up to July 2024. Sources: DGCI&S; CPB Netherlands; and RBI staff estimates. cent in July-August 2024 (Chart III.17). The growth growth in Q1 and 12.1 per cent in July-August 2024 on in services exports was mainly driven by software, the back of buoyant domestic demand. business, transportation and travel services, reflecting On a balance of payments basis, the current account improving global demand for Indian services. Among deficit widened marginally to 1.1 per cent of GDP in the major exporters of services globally, India retained Q1:2024-25 from a deficit of 1.0 per cent of GDP in its position in the top ten exporting countries during Q1:2023-24 and a surplus of 0.5 per cent of GDP in January-June 2024. Services imports moved out of Q4:2023-24, mainly due to higher merchandise trade the contractionary zone, posting a 7.2 per cent y-o-y deficit. For the fiscal year 2023-24, the current account Chart III.16: Merchandise Imports Note: Figures in parentheses in chart b are y-o-y per cent change in imports of the commodity during the period. Sources: DGCI&S; and RBI staff estimates. 46Chapter III Demand and Output Chart III.17 Services Trade Chart III.18: Net Foreign Direct and Portfolio Investment Notes: Net FDI data for Q2: 2024-25 is up to July 2024. Note: P: Provisional. P: Provisional. Source: RBI. Sources: National Securities Depository Limited (NSDL); and RBI. deficit (CAD) narrowed to 0.7 per cent of GDP from 2.0 External commercial borrowing flows moderated to per cent in 2022-23, driven by a lower merchandise US$ 3.6 billion in April-August 2024 from US$ 4.3 trade deficit, robust services exports and substantial billion a year ago. On the other hand, net accretions inward remittances. to non-resident deposits surged to US$ 5.8 billion in April-July 2024 from US$ 3.0 billion a year ago, led by In the financial account, net FDI flows increased to higher inflows in all three accounts [foreign currency US$ 4.9 billion in April-July 2024 from US$ 3.8 billion non-resident (FCNR), non-resident external (NRE) a year ago, on account of robust gross equity inflows and non-resident ordinary (NRO) accounts]. As on (Chart III.18). Singapore, Mauritius, Netherlands, September 27, 2024 India’s foreign exchange reserves USA and Belgium were the major sources of FDI inflows, accounting for a share of 70.8 per cent. On amounted to US$ 704.9 billion, equivalent to 12.1 the sectoral front, manufacturing, financial services, months of annualised merchandise imports as per communication services, computer services and BoP basis and 103.3 per cent of outstanding external electricity and other generation, distribution and debt at end-June 2024. transmission attracted the majority of FDI equity III.2 Aggregate Supply inflows with a share of 77.3 per cent. Aggregate supply – measured by real gross value added Foreign portfolio investment (FPI) moderated in (GVA) at basic prices – expanded by 6.8 per cent y-o-y Q1:2024-25 mainly due to net outflows in equities, in Q1:2024-25 (8.3 per cent a year ago)- a three-quarter though debt inflows have remained robust after the high, supported by industry and services (Table III.5). announcement of inclusion of Indian government The momentum of GVA improved over the previous bonds in the J.P.Morgan’s benchmark emerging market quarter (Chart III.19). index. FPI inflows, however, registered a turnaround III.2.1 Agriculture in Q2:2024-25 with continued surge in debt inflows and a revival in equity flows. FPI inflows of US$ 20.1 Real GVA in agriculture, forestry and fishing slowed billion were recorded in H1: 2024-25 as against net to 2.0 per cent in Q1:2024-25 (3.7 per cent a year ago) inflows of US$ 20.3 billion a year ago. on account of muted growth in foodgrains production 4477Monetary Policy Report October 2024 Table III.5: Real GVA Growth (y-o-y, per cent) Sector 2022- 2023- Weighted 2022-23 2023-24 2024-25 23 24 Contribution (FRE) (PE) 2022-23 2023-24 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Agriculture, forestry and fishing 4.7 1.4 0.7 0.2 2.7 2.3 5.2 7.6 3.7 1.7 0.4 0.6 2.0 Industry -0.6 9.3 -0.1 2.0 4.0 -5.5 -2.8 1.7 5.0 13.6 10.8 8.3 7.4 Mining and quarrying 1.9 7.1 0.0 0.2 6.6 -4.1 1.4 2.9 7.0 11.1 7.5 4.3 7.2 Manufacturing -2.2 9.9 -0.4 1.7 2.2 -7.2 -4.8 0.9 5.0 14.3 11.5 8.9 7.0 Electricity, gas, water supply and other 9.4 7.5 0.2 0.2 15.6 6.4 8.7 7.3 3.2 10.5 9.0 7.7 10.4 utilities Services 9.9 7.9 6.1 5.0 16.4 9.4 7.5 7.3 10.4 6.9 7.5 7.0 7.7 Construction 9.4 9.9 0.8 0.9 14.7 6.9 9.5 7.4 8.6 13.6 9.6 8.7 10.5 Trade, hotels, transport, 12.0 6.4 2.1 1.2 22.1 13.2 9.2 7.0 9.7 4.5 6.9 5.1 5.7 communication Financial, real estate and professional 9.1 8.4 2.0 1.9 10.5 8.7 7.7 9.2 12.6 6.2 7.0 7.6 7.1 services Public administration, defence and 8.9 7.8 1.1 1.0 23.6 7.3 3.5 4.7 8.3 7.7 7.5 7.8 9.5 other services GVA at basic prices 6.7 7.2 6.7 7.2 11.3 5.0 4.8 6.0 8.3 7.7 6.8 6.3 6.8 Note: FRE: First revised estimates; PE: Provisional estimates. Sources: NSO; and RBI staff estimates. during rabi and summer seasons. The southwest distribution (Chart III.20b). The robust progression monsoon (SWM) commenced at a sluggish pace in June; of monsoon rains enabled increased acreage of however, it gained momentum from July onwards. By kharif sowing, which saw a 1.9 per cent rise over the July 2, 2024, monsoon rainfall had covered the whole previous year and exceeded normal sowing levels country and precipitation turned into a surplus of 8 by 1.7 per cent as of September 27, 2024. The area per cent by September 30, 2024 (Chart III.20a). Out devoted to all major crops, barring cotton, was greater of the 36 sub-divisions, 33 experienced normal or than in the previous year. Specifically, the area under above-normal rainfall, reflecting a broadly equitable rice – constituting nearly 37 per cent of the kharif Chart III.19: GVA Growth and Momentum sowing area – rose by 2.5 per cent from the previous year’s acreage. Similarly, the area covered by pulses and oilseeds sowing expanded by 7.4 per cent and 2.7 per cent, respectively (Chart III.20c). The enhanced rainfall also facilitated the replenishment of reservoir levels to 87 per cent of total capacity as of September 26, 2024, a marked improvement from the historically low levels recorded in June 2024 (Chart III.20d). With these elevated reservoir levels and the anticipated onset of La Niña later in the year, the outlook for rabi crop appears promising. As of September 30, 2024 the production-weighted rainfall index (PRN) stood at 107 per cent, surpassing the 93 per cent level recorded during the same period last year (Chart III.20e). The resurgence of rainfall in the North-Western states Note: saar - Seasonally adjusted annualised rate. Sources: NSO; and RBI staff estimates. of India contributed to a higher PRN relative to the 48Chapter III Demand and Output Chart III.20: Progress of Rainfall and Kharif Sowing Notes: *Normal area as on date is the average of 5 years - 2019-20 to 2023-24. FRL: Full Reservoir Level; LPA: Long Period Average. Sources: India Meteorological Department (IMD); Central Water Commission; Ministry of Agriculture and Farmers' Welfare; and RBI staff estimates. previous year. Furthermore, the crop-specific PRN basis by 1.5 per cent and 2.5 per cent, respectively, exceeded both last year's position and the five-year whereas coarse cereals, pulses, oilseeds, sugarcane average across all crops (Chart III.20f). and cotton recorded a decline in production during the year (Table III.6). According to the final estimates of crop production for 2023-24, total foodgrain production at 3,323 lakh The government announced an increase of 1.4–12.7 tonnes recoded an increase of 0.8 per cent over the per cent in minimum support prices (MSP) for kharif final estimates of 2022-23 and 1.0 per cent over the 2024-25 crops, ensuring a return of at least 50 third advance estimates of 2023-24. Among major per cent over the cost of production (as measured crops, rice and wheat production increased on y-o-y by A2 plus FL10). This adjustment aligns with the 10 A2 (out of pocket expenses) plus FL (family labour) includes all paid out costs such as expenses on hired labour, machines, rent paid for leased land, seeds, fertilisers, irrigation charges, depreciation as well as imputed value of family labour. 4499Monetary Policy Report October 2024 Table III.6: Agriculture Production in 2023-24 (Lakh tonnes) Item 2022-23 2023-24 Variation in 2023-24 (Per cent) Final Third AE Final Over Third AE Over 2022-23 2023-24 Foodgrains 3296.9 3288.5 3323.0 1.0 0.8 Kharif 1557.1 1566.8 1557.7 -0.6 0.0 Rabi 1578.4 1576.6 1600.1 1.5 1.4 Summer 161.4 145.2 165.2 13.8 2.4 Rice 1357.6 1367.0 1378.3 0.8 1.5 Wheat 1105.5 1129.3 1132.9 0.3 2.5 Coarse Cereals 573.2 547.3 569.4 4.0 -0.7 Pulses 260.6 244.9 242.5 -1.0 -7.0 Oilseeds 413.6 395.9 396.7 0.2 -4.1 Sugarcane 4905.3 4425.2 4531.6 2.4 -7.6 Cotton# 336.6 325.2 325.2 0.0 -3.4 Jute & Mesta## 93.9 97.1 96.9 -0.2 3.2 Notes: #: Lakh bales of 170 kgs each; # #: Lakh bales of 180 kgs each. AE: Advance estimates Source: Ministry of Agriculture and Farmers’ Welfare. Government’s recent efforts to recalibrate MSPs in held by the Food Corporation of India at 408.8 lakh favour of oilseeds, pulses, and nutri-cereals, aiming tonnes as of September 16, 2024 was the highest ever to foster crop diversification, rectify the demand- held by them compared to the corresponding date in supply disparity, and advance sustainable agricultural the previous years and is 3 times the quarterly buffer practices. Procurement of rice during the kharif norms. Rice allocation under the Open Market Sales marketing season 2023-24 (up to September 30, 2024) Scheme (OMSS) fell way short of the target, partly at 525.4 lakh tonnes was 7.7 per cent lower than in the owing to subdued demand for the variety of rice previous year. Despite this reduction, the stock of rice offered by the corporation (Chart III.21a). In contrast, Chart III.21: Stock, Procurement and Offtake Position – Rice and Wheat Sources: Food Corporation of India; and GoI. 50Chapter III Demand and Output wheat procurement during the rabi marketing season Mining and quarrying recorded a growth of 7.9 per 2024-25 stood at 266.1 lakh tonnes, reflecting a 1.6 per cent in Q1 and 3.7 per cent in July. Manufacturing cent increase over the previous year. The wheat stock recorded an expansion of 4.1 per cent in Q1 (5.1 per of 246.8 lakh tonnes, however, fell short of the buffer cent during the previous year) and 4.6 per cent in requirement by 29.0 lakh tonnes (Chart III.21b). July, while electricity registered a robust expansion of 10.8 per cent in Q1 (1.3 per cent during the previous III.2.2 Industry year) and 7.9 per cent in July. While the production Industrial GVA expanded by 7.4 per cent in Q1:2024- of basic metals, electrical equipment, motor vehicles 25 (5.0 per cent a year ago), primarily on account and other transport equipment recorded an upsurge of stronger manufacturing activity than a year ago, in Q1 and July, food products, textiles, and leather despite some build-up of supply chain pressures and related products acted as a drag on growth. In due to the rise in global freight and container costs. terms of the use-based classification, primary, capital, Manufacturing GVA expanded by 7.0 per cent y-o-y intermediate, infrastructure and consumer durables during Q1 on top of 8.9 per cent growth in Q4. GVA rose during Q1 and July. Consumer non-durable in mining and electricity, gas, water supply, and goods, however, registered a contraction during this other utility services increased at a pace of 7.2 per period. cent and 10.4 per cent y-o-y, respectively, during Q1 Electricity, gas, water supply and other utility (Chart III.22). services remained strong and posted a growth of 10.4 The index of industrial production (IIP) grew by per cent y-o-y in Q1, reflecting underlying demand 5.4 per cent in Q1:2024-25 and 4.8 per cent in July, conditions. Electricity generation rose sharply by with support from all constituents – mining, 7.2 per cent y-o-y during April-August 2024 (5.5 per manufacturing, and electricity generation (Chart III.23 cent a year ago), driven by thermal power generation and Table III.7). which registered a growth of 7.8 per cent. Renewable Chart III.22 Industrial GVA Growth Note: Data for Q1:2024-25 are based on results of 1,690 listed private manufacturing companies. Sources: NSO: and RBI staff estimates. Source: RBI staff estimates based on data published by listed companies. 5511Monetary Policy Report October 2024 Chart III.23: Index of Industrial Production (IIP) Sources: NSO; and RBI staff estimates. energy sources, with a share of around 14.0 per cent pick-up in demand from the northern region amidst in total electricity generation, registered a growth of extended spells of heatwaves, except a marginal 6.1 per cent during April-August 2024 (Chart III.24a). moderation in western region. Electricity demand Region-wise, electricity demand remained strong in contracted in August 2024 owing to a high base all regions during April-August 2024, with a sharp (Chart III.24b). Table III.7: Industrial Sector y-o-y growth (per cent) Indicators 2023-24 2024-25 Q1 Q2 Q3 Q4 Q1 Jul Aug Sep 1 PMI: Manufacturing 57.9 57.9 55.5 57.5 58.2 58.1 57.5 56.5 (>50 indicates growth over previous month) 2 Index of Industrial Production (IIP) 4.8 7.8 6.1 5.1 5.4 4.8 3 IIP: Manufacturing 5.1 6.8 5.4 4.8 4.1 4.6 4 IIP: Primary goods 3.6 9.3 8.1 3.9 6.9 5.9 5 IIP: Capital goods 5.1 8.8 7.5 4.1 3.2 12.0 6 IIP: Infrastructure and construction goods 13.2 12.8 6.5 7.1 7.3 4.9 7 IIP: Consumer durables -2.7 1.1 5.3 11.2 10.6 8.2 8 IIP: Consumer non-durables 6.8 7.0 2.5 0.7 -0.5 -4.4 9 Eight Core Industries (ECI) 6.0 10.5 8.4 5.8 6.3 6.1 -1.8 10 ECI: Steel 16.5 15.4 10.5 8.7 8.5 6.4 4.5 11 ECI: Cement 12.7 10.3 5.1 7.6 0.5 5.5 -3.0 12 Electricity demand 1.5 13.9 9.9 8.1 10.2 4.0 -6.5 Production of Automobiles 13 Passenger vehicles 7.0 5.6 5.0 9.7 5.8 1.2 0.7 14 Two wheelers 1.3 -1.5 19.0 26.4 19.6 21.1 4.9 15 Three wheelers 24.4 19.6 13.4 8.4 9.4 6.0 9.0 16 Tractors -8.9 -10.1 -13.0 -15.1 1.0 8.1 -1.0 Sources: MOSPI; Office of Economic Adviser; CEIC; NSO; SIAM; HSBC, S&P Global; and RBI staff estimates. 52Chapter III Demand and Output Chart III.24: Electricity Generation and Consumption Sources: Central Electricity Authority; and Power System Operation Corporation Limited (POSOCO). The manufacturing purchasing managers’ index III.2.3 Services (PMI) stayed in expansion mode all through H1:2024- Services remained the mainstay of the economy, with 25, though it eased to 57.4 in Q2 from 58.2 in Q1 a contribution of over 70 per cent to GVA growth in with a moderation in new orders-both domestic Q1:2024-25. Services sector GVA growth accelerated to and exports. The future output index moderated 7.7 per cent in Q1 from 7.0 per cent in Q4:2023-24, marginally but remained in expansion at 63.9 in H1 with the impetus from construction activity; financial, (Chart III.25a). real estate and professional services; and public Chart III.25: PMI Manufacturing and Services Note: PMI>50: Expansion, PMI< 50: Contraction. Sources: HSBC, S&P Global. 5533Monetary Policy Report October 2024 administration, defence and other services (Chart Real GVA growth in financial, real estate and III.26a). High frequency indicators point to strong professional services rose by 7.1 per cent y-o-y in construction activity in H1;2024-25 (up to August) – Q1:2024-25 and was a major contributor to service steel consumption recorded a robust growth, while sector GVA growth (38.1 per cent) as well as to cement production remained subdued on account aggregate GVA growth (27.7 per cent). Bank credit of heat waves, and an unfavourable base effect and deposits expanded by 14.4 per cent (y-o-y) and (Chart III.26b). 12.0 per cent, respectively, as on September 20, 2024 GVA growth of trade, hotels, transport, and suggesting continued buoyancy in financial services. communication accelerated to 5.7 per cent y-o-y Moreover, the growth of insurance premia in both in Q1:2024-25 (5.1 per cent in Q4:2023-24). GST life and non-life segments remained healthy in H1 collections and issuances of e-way bills – indicators (April-August) (Table III.8). of wholesale and retail trade – point towards robust Nominal sales of non-IT services grew by 6.3 per economic activity. Domestic air passenger traffic cent during Q1:2024-25 as against 10.4 per cent improved in H1:2024-25, reflecting sustained growth during Q4:2023-24. The performance of the IT sector in tourism and business-related travel. Indicators of improved in Q1 after decelerating in the previous six transportation services displayed a mixed picture quarters (Chart III.27). – commercial vehicle sales growth rebounded in Q1:2024-25 following a contraction in Q4:2023-24; Real estate activity in Q1:2024-25 remained robust, the growth in toll collections remained subdued in with a moderation in unsold inventory as sales Q1 before improving in Q2; port cargo and railway surpassed new launches for the third consecutive freight traffic recorded a modest growth of 5.0 per quarter (Chart III.28a). The growth in all-India cent and 3.9 per cent, respectively, in H1; 2024-25 housing prices moderated in Q1:2024-25; largely due (up to August). to a drop in prices in Delhi (Chart III.28b). Public Chart III.26: Services Sector Sources: NSO; Office of Economic Adviser; and Joint Plant Committee. 54Chapter III Demand and Output Table III.8: Services Sector y-o-y growth (per cent) Indicators 2023-24 2024-25 Q1 Q2 Q3 Q4 Q1 Jul Aug Sep 1 PMI: Services (>50 indicates growth over previous month) 60.6 61.1 58.1 61.2 60.5 60.3 60.9 57.7 Construction 2 Steel consumption 12.1 17.6 14.5 10.7 15.0 14.4 10.0 3 Cement production 12.7 10.3 5.1 7.6 0.5 5.5 -3.0 Trade, Hotels, Transport, Communication and Services related to Broadcasting 4 Commercial vehicle sales -3.5 6.9 3.5 -3.8 3.5 5 Domestic air passenger traffic 19.1 23.0 9.1 5.2 5.6 7.6 6.7 6 Domestic air cargo -4.7 -1.0 9.5 10.0 7.1 8.8 0.6 7 International air cargo 0.1 3.7 10.7 23.9 18.4 24.4 20.7 8 Freight traffic 1.1 4.8 6.4 8.4 5.0 4.5 0.0 9 Port cargo 1.9 2.9 10.1 3.1 3.9 6.0 6.7 10 Toll collection: volume 15.4 13.3 12.8 10.9 5.6 9.4 6.8 6.5 11 Petroleum consumption 6.4 6.3 2.1 5.5 3.9 10.6 -2.3 -1.6 12 GST E-way bill 15.8 15.0 17.1 16.3 16.0 19.2 12.9 18.5 13 GST revenue 11.6 10.6 12.9 11.5 10.2 10.3 10.0 6.5 Financial, Real Estate and Professional Services 14 Credit outstanding 16.2 15.3 15.6 16.3 13.9 15.1 15.0 14.4 15 Bank deposits 12.9 12.3 12.6 12.9 10.6 11.0 11.3 12.0 16 Life insurance premium -0.9 -21.2 5.4 26.0 22.9 14.2 21.9 17 Non-life insurance premium 17.8 12.6 12.1 9.5 13.3 9.3 4.2 Sources: CEIC; NSO; HSBC, S&P Global; MOSPI; IRDAI; and RBI staff estimates. administration, defence, and other services (PADO) Q1:2024-25. The centre’s revenue expenditure, grew at an 8-quarter high of 9.5 per cent y-o-y in excluding interest payments and subsidies, contracted by 1.5 per cent in Q1 before expanding Chart III.27: Nominal Sales Growth by 9.6 per cent during July-August. Healthy growth in other services like health, education and other personal services, however, helped in offsetting muted government consumption in Q1. The services PMI remained in expansionary zone at 60.5 in Q1:2024-25 and 59.6 in Q2, slightly down from 61.2 in Q4:2023-24, supported by strong demand and new business activity (Chart III.25b). The composite PMI index declined marginally from 61.2 in Q4:2023-24 to 61.0 in Q1:2024-25, and further to 59.9 in Q2, PMI manufacturing and PMI services readings for India have remained the Note: Results are based on 2,934 listed non-government non-financial companies highest globally since July 2022 and April 2023, for Q1: 2024-25. Source: RBI staff estimates. respectively. 5555Monetary Policy Report October 2024 Chart III.28: Housing Sector – Launches, Sales and Prices Sources: PropTiger; and RBI. III.3 Conclusion prospects, sustained buoyancy in services, consumer Domestic economic activity has held up well in and business optimism, the government’s continued H1:2024-25, despite slowdown in government thrust on capex and healthy balance sheets of expenditure. Private consumption rebounded banks and corporates should support economic strongly, with rural demand augmenting sustained activity. Geopolitical tensions and geo-economic urban demand. Investment activity demonstrated fragmentation, volatility in global financial markets, resilience despite lower government capex in unseasonal rains and weather disturbances pose Q1:2024-25. Looking ahead, brighter agriculture downside risks to the domestic outlook. 56Chapter IV Financial Markets and Liquidity Conditions IV. Financial Markets and Liquidity Conditions Domestic financial markets exhibited orderly movements in contrast to volatile global market conditions during H1:2024-25. Money market rates evolved in line with liquidity shifts while long-term bond yields eased. Banks’ lending and deposit rates increased, reflecting ongoing monetary policy transmission. The Reserve Bank conducted two-way market operations while ensuring adequate liquidity to meet the productive requirements of the economy. Introduction resilient. Money market rates evolved in sync with liquidity shifts. Long-term government bond yields During H1:2024-25, global financial markets sporadically turned volatile in response to changing eased in response to domestic developments and perceptions on the future monetary policy trajectory, global cues. Equity markets remained buoyant, sparked by data releases. Global bond yields with sporadic episodes of course corrections. The moderated in response to the improving inflation INR traded with a depreciating bias against the US outlook and cooling labour markets. Global equity dollar in H1 but remained among the least volatile markets gained in H1 amidst intermittent bouts major EME currencies. In the credit market, growth of sell-offs. The US dollar traded with a weakening in bank credit outpaced deposit expansion although bias and currencies of emerging market economies the wedge has narrowed more recently. (EMEs) mirrored its movements, exacerbated by IV.1.1 Money Market swings in capital flows. Since the second half of September, however, bond yields hardened and the During H1:2024-25, liquidity conditions transitioned dollar index firmed up reversing its earlier trend (see to surplus from deficit in H2:2023-24 (see Section Chapter V for details). IV.3 for details). As a result, overnight money market IV.1 Domestic Financial Markets rates softened and generally remained within In contrast to global developments, domestic the Liquidity Adjustment Facility (LAF) corridor financial markets remained relatively stable and (Chart IV.1a). Chart IV.1: Policy Corridor and WACR Sources: Reserve Bank of India (RBI); and RBI staff calculations 5577Monetary Policy Report October 2024 In response to the changing liquidity dynamics, the rates in the collateralised segment, i.e., tri-party repo Reserve Bank conducted two-way operations under (TREPS) and market repo were broadly aligned with the LAF to ensure that the weighted average call rate the WACR. (WACR) – the operating target of monetary policy – Money market activity was dominated by the remained closely aligned with the policy repo rate. collateralised segments, with their share in overnight The WACR increased sharply during June 27-28 due money market volumes remaining unchanged at 98.0 to quarter-end liquidity tightness, also evident from per cent in H1 (Chart IV.2). a sudden spike in borrowings under the marginal Mutual funds (MFs) remained the major lenders in standing facility (MSF). The WACR, which remained TREPS, although their share moderated to 65 per cent mostly above the repo rate until end-June 2024, in H1 from 66 per cent in H2:2023-24. In the market moderated from July 2024 as liquidity conditions repo segment, the share of MFs increased to 41 per eased with a pick-up in government spending. At cent in H1 from 33 per cent, with a concomitant the end of H1 (September 30), however, the WACR decline in the share of foreign banks to 34 per cent increased by 15 bps on account of banks reducing from 43 per cent. On the borrowing side, public their exposures in the uncollateralised market which sector banks (PSBs) remained the dominant players incur higher Capital to Risk (Weighted) Assets Ratio in TREPS, with their share increasing to 47 per cent (CRAR) requirements in the ensuing quarter.1 On an in H1 from 45 per cent in H2:2023-24. In market repo, average basis, the WACR remained 5 basis points (bps) however, their share reduced to 4 per cent from 9 per above the policy repo rate during H1, as compared cent over the same period. with 21 bps in H2:2023-24 (Chart IV.1b). Volatility in the WACR, as measured by the coefficient of variation In the longer-term segments of the money market, (CV), moderated to 1.61 per cent during H1 from 1.77 rates on commercial papers (CPs), certificates per cent during H2:2023-24. Movements in overnight of deposit (CDs) and T-bills softened during H1 Chart IV.2: Share in Overnight Money Market Volumes Chart IV.3: Money Market Rates and Policy Corridor Sources: Clearing Corporation of India Ltd. (CCIL); and RBI. Sources: CCIL; and RBI. 1 Additionally, the tightness in the overnight segment was compounded by mutual funds reducing their lending in tri-party repo due to redemption pressures. 58Chapter IV Financial Markets and Liquidity Conditions relative to H2:2023-24 due to improved liquidity in Chart IV.4: Tenor Wise Break up of CD Issuances the banking system and reduced supply of shorter maturity T-bills (Chart IV.3). Rates on CPs issued by non-banking financial companies (NBFCs), however, remained elevated reflecting, inter alia, the increase in risk weights on bank lending to NBFCs announced by the Reserve Bank on November 16, 2023. The average spreads of T-bills, CDs and CPs over the MSF rate softened to zero, 49 bps and 61 bps, in H1 from 19 bps, 74 bps and 100 bps, respectively, in H2:2023-24. Fresh issuances of CDs moderated to 4.0 lakh crore in H1 from 5.5 lakh crore in H2:2023-24, mainly ₹ due to surplus liquidity conditions since July 2024. ₹ Within H1, CD issuances in the shorter tenor (up to Sources: CCIL; and RBI staff estimates. 91-day) declined, with their share in total issuances reducing to 54 per cent in July 2024 from 84 per cent lakh crore in H2:2023-24 (Chart IV.5a). Among fresh in May 2024. Concomitantly, the share of longer tenor issuances, the average share of NBFCs increased to 32 CDs (181-365 days) increased to 45 per cent in July per cent in H1 from 29 per cent in the corresponding 2024 from 14 per cent in May 2024 (Chart IV.4). The period of the previous year. Thus, NBFCs have persistent gap in credit and deposit growth prompted resorted to greater mobilisation of resources from the banks to explore alternative sources such as CDs of market in the wake of the November 2023 measures, longer tenors to bridge the funding gap. as mentioned earlier. In the CP market, corporates Resource mobilisation through fresh issuances of were the major players with a share of 38 per cent in CPs increased to 7.5 lakh crore during H1 from 6.7 total issuances (Chart IV.5b). ₹ Chart IV.5: Primary I₹ssuances of Commercial Papers Sources: RBI; CCIL F-TRAC; and RBI staff estimates. 5599Monetary Policy Report October 2024 week of May, buoyed by positive sentiments on the Table IV.1: Maturity Profile of CP Issuances inclusion of Indian G-secs in global bond indices and ( lakh crore) the buyback of government paper. Yields remained Tenor H1: H2: ₹ H1: 2023-24 2023-24 2024-25 largely stable during the month of June and July, 7- 30 days 0.45 0.48 0.63 moderating towards the end of July due to market 31-90 days 3.18 2.32 2.35 reactions to a potential increase in the Liquidity 91-180 days 2.75 3.11 3.94 Coverage Ratio (LCR) based on the draft guidelines on 181-365 days 0.70 0.77 0.64 LCR issued by the RBI. Yields continued to moderate Total 7.09 6.67 7.55 in August and September on lower inflation prints Outstanding (as at end-period) 4.12 3.89 3.98 Sources: CCIL; F-TRAC; and RBI. (for July and August) and the start of the policy easing cycle in the US. Among various maturity buckets, the 91-180 days The yields on T-bills moderated during May and June segment had the largest share of fresh CP issuances amidst reduction in the supply of T-bills by 60,000 [52 per cent in H1 (Table IV.1)]. crore. The softening bias continued to prevail IV.1.2 Government Securities (G-sec) Market ₹ thereafter till September as liquidity continued During H1, G-sec yields softened (Chart IV.6). At the to remain in surplus and also in the wake of the beginning of the financial year, yields hardened, cancellation of treasury bill auctions scheduled for tracking movements in US yields and the increase the second half of the month (Chart IV.7). in crude oil prices. Thereafter, they eased during the The average trading volume in G-secs and T-bills first week of May with the softening of US yields and increased in H1:2024-25 relative to H2:2023-24 easing crude oil prices in the wake of the US Federal (Chart IV.8). The weighted average yield (WAY) on Open Market Committee’s (FOMC’s) announcement traded maturities for G-secs and T-bills declined by to reduce the pace of balance sheet runoff from June 23 bps and 19 bps, respectively, in H1 from that in 2024. Yields eased further in the second and third H2:2023-24. Chart IV.6: 10-year Par Yield, Repo Rate and Chart IV.7: FBIL T-bill Benchmark Liquidity Conditions (Yield to Maturity) Sources: RBI; and Financial Benchmarks India Pvt. Ltd. (FBIL). Source: FBIL. 60Chapter IV Financial Markets and Liquidity Conditions Chart IV.8: Trading Volumes and Yield Sources: CCIL; and RBI staff estimates. The overall dynamics of the yield curve are captured yield curve increased by 26 bps due to the relatively by its latent factors viz., level, slope and curvature2. higher decline in short-term rates (Chart IV.9b). The Yields have softened across the term structure as curvature, on the other hand, increased by 18 bps, reflected in the downward shift of the yield curve reflecting the hardening bias in the mid-segment during H1 (Chart IV.9a), with the average level of vis-à-vis the short and long term. In the Indian yields softening by 29 bps while the slope of the context, the level and curvature of the yield curve are Chart IV.9: G-sec Yield Curve Sources: FBIL; and RBI staff estimates. 2 The level is the average of par yields of all tenors up to 30-years published by FBIL and the slope (term spread) is the difference in par yields of 3-months and 30-year maturities. The curvature is calculated as twice the 15-year yield minus the sum of 30-year and 3-month yields. 6611Monetary Policy Report October 2024 found to have more information content on future Chart IV.10: SGS - Amount Raised and Spread macroeconomic outcomes than the slope, unlike in AEs (Patra et al, 2022)3. On a review of prevailing market conditions, the Reserve Bank, in consultation with the Government of India (GoI), announced that all securities under the market borrowing programme of the GoI shall be auctioned by the multiple price auction method, effective April 1, 2024. The return to multiple price auctions for all the securities after a gap of three years was aimed at encouraging better price discovery in the G-sec market. To facilitate debt consolidation, the Reserve Bank conducted six switch auctions on behalf of the GoI, Source: RBI. amounting to 1.16 lakh crore during H1:2024-25. IV.1.3 Corporate Bond Market Even as the weighted average maturity (WAM) of the ₹ outstanding stock of G-secs increased to 12.96 years Corporate bond yields softened while spreads at end-September 2024 from 12.54 years at end-March widened during H1:2024-25. Issuer-wise, the 2024, the weighted average coupon (WAC) at 7.28 per average yield on AAA-rated 3-year bonds issued cent was nearly identical to 7.29 per cent over the by public sector undertakings (PSUs), financial same period. institutions (FIs) and banks softened by 10 bps (to 7.53 per cent), while those by non-banking financial In May and early June 2024, five buyback auctions were companies (NBFCs) and corporates declined by 14 announced with a view to retiring some of the GoI's bps (to 7.84 per cent) and 15 bps (to 7.80 per cent), debt ahead of schedule, particularly in the backdrop respectively, in September over March 2024 (Chart of its improved cash position.4 The market response IV.11a). Nevertheless, the risk premium (the spread to the auctions, however, was tepid, with the Reserve of 3-year AAA corporate bond yields over 3-year G-sec Bank accepting offers aggregating only 0.3 lakh crore yields) increased from 44 bps to 71 bps for PSUs, against the notified amount of 2.3 lakh crore. FIs and banks; from 80 bps to 102 bps for NBFCs; ₹ The weighted average spread₹ of cut-off yields on and from 77 bps to 97 bps for corporates, in H1:2024-25 due to sharper decline in G-sec yields state government securities (SGS) over GoI G-sec yields (Chart IV.11b). of comparable maturities was 31 bps in H1:2024- 25 (Chart IV.10). The average inter-state spread on The increase in risk premia was evident across securities of 10-year tenor (fresh issuances) was 2 bps tenors and the rating spectrum amidst moderation in H1 as against 4 bps in H2:2023-24. in corporate performance in Q1:2024-25 (Table IV.2). 3 Patra, M.D., Joice, J., Kushwaha, K.M., and I. Bhattacharyya (2022), “What is the Yield Curve telling us about the Economy?”, Reserve Bank of India Bulletin, June. 4 Although buybacks have a liquidity impact, they should not be construed as liquidity management operations; instead, they are part of an active debt consolidation strategy. 62Chapter IV Financial Markets and Liquidity Conditions Chart IV.11: AAA-rated 3-Year Corporate Bond Yield and Spreads Note: Data are monthly averages for spreads over G-secs. Source: Fixed Income Money Market and Derivatives Association of India (FIMMDA). In contrast, the average 3-year credit default swap H2:2023-245 (Chart IV.12a). Overseas issuances at (CDS) spreads that are trading overseas for the State 29,029 crore during H1 were lower than 31,492 Bank of India and ICICI Bank reduced by 3 bps each crore during H2:2023-24. Almost the entire resource ₹ ₹ in H1 over H2:2023-24. mobilisation in the corporate bond market (99.0 per cent) was through the private placement route Primary issuances of listed corporate bonds in (up to August 2024). Outstanding investments by domestic markets declined to 3.3 lakh crore during foreign portfolio investors (FPIs) in corporate bonds H1 (up to August 2024) from 4.6 lakh crore during ₹ increased to 1.18 lakh crore at end-September Table IV.2: Financial Market₹s - Rates and Spread 2024, from 1.08 lakh crore at end-March 2024, ₹ Interest Rates Spread (bps) with the utilisation of the approved limits ₹ (per cent) (over corresponding improving marginally to 16.4 per cent from 16.2 risk-free rate) per cent over the same period (Chart IV.12b). Instrument SeptemberMarchSeptemberSeptemberMarchSeptember 2023 2024 2024 2023 2024 2024 Secondary market activity, however, picked up 1 2 3 4 5 6 7 with daily average trading volume at 6,168 crore Corporate during H1 (up to end-July 2024) from 5,791 Bonds ₹ crore during H2:2023-24 (Chart IV.12c). (i) AAA (1-yr) 7.68 7.97 7.92 53 77 117 ₹ From a regulatory perspective, the Securities (ii) AAA (3-yr) 7.83 7.95 7.80 51 77 97 and Exchange Board of India (SEBI) lowered (iii) AAA (5-yr) 7.69 7.74 7.70 37 54 86 the denomination of debt securities for private (iv) AA (3-yr) 8.46 8.55 8.55 113 137 172 placements to 10,000 from 1 lakh with a view (v) BBB-minus 12.14 12.19 12.14 481 500 531 (3-yr) to encouraging retail participation and enhancing ₹ ₹ Note: Yields and spreads are computed as monthly averages. liquidity in the corporate bond market. Source: FIMMDA. 5 Issuances in the first half of the financial year are usually lower than the second half as the borrowing plans of corporates are chalked out gradually. Moreover, central government borrowing is usually frontloaded, which provides greater space to corporates for resource mobilisation in the second half. 6633Monetary Policy Report October 2024 Chart IV.12: Corporate Bond Market Activity Note: * Data for domestic issuances is up to August 2024 while data for overseas issuances is up to September 2024. Sources: SEBI; NSDL; and Prime Database. IV.1.4 Equity Market wake of positive market sentiments from improved GoI finances and other domestic and global cues. In Despite transient surges in volatility, Indian equity early June, the market exhibited large swings during markets maintained an upward trajectory in the announcement of Lok Sabha election results, H1:2024-25, with the BSE Sensex surpassing the which drove the India VIX6 to its highest levels since historic 80,000 mark in July 2024. Amidst these gains, the onset of the Russia-Ukraine war. market valuation, as measured by the trailing price- earnings ratio of the BSE Sensex, continued to remain Thereafter, markets recovered quickly amidst above its long-term average and reached 24.8 at end- expectations of policy continuity, release of softer September 2024. Indian equities began the financial than-expected domestic as well as US inflation for year positively, driven by strong domestic and global May and India’s current account turning into a surplus macroeconomic data and robust domestic corporate in Q4:2023-24. In July, gains in IT sector stocks and earnings. Thereafter, markets declined briefly amidst dovish signals from the US Fed propelled the Sensex rising geopolitical tensions in the Middle-East. After past the 80,000 mark before its correction later in the the initial losses in May, the market capitalisation of month on the budgetary announcement of changes in Indian listed companies surpassed US$ 5 trillion in the the capital gains tax structure. 6 A measure of short-term expected volatility of Nifty 50. 64Chapter IV Financial Markets and Liquidity Conditions Indian financial markets faced a fresh bout of global market volatility and a significant churning volatility in early August 2024 on account of a of portfolio flows. Thereafter, markets recovered combination of factors: (i) elevated geopolitical as expectations of a US Fed rate cut grew stronger tensions in the Middle-East; (ii) weaker-than- after the release of dovish US FOMC minutes and the expected economic data from the US; and (iii) the remarks of the US Fed Chairman at the Jackson Hole Bank of Japan (BoJ) raising rates for the second time Economic Symposium hinting at the possibility of an in 17 years. The BoJ's actions prompted a sudden and imminent policy pivot. The resulting surprises on large unwinding of yen carry trade. The resulting the future path of monetary policy have a profound US equity market meltdown led to heightened impact on financial asset prices (Box IV.1). Domestic Box IV.1: Monetary Policy Surprises and Equity Markets Monetary policy surprises can be decomposed into Chart IV.1.1: Estimated Target and Path factors ‘target’ and ‘path’ factors. The former reflects unexpected changes in the contemporaneous policy rate, while the latter represents surprises in its future trajectory. Intraday changes in 1-year MIBOR-linked OIS rates on policy announcement days are used as a measure of policy surprise (Lloyd, 2018).7 The target factor is the difference between the actual repo rate and the mean expectations of the repo rate from the Bloomberg Economists’ survey (Anderson 2010). The path factor is estimated as the residual of a regression of changes in OIS rate on the target factor: (1) Source: where is the change in 1-year OIS rates, i is the RBI staff estimates. t where the subscript represents changes/returns in actual repo rate, is the expected/mean repo rate in the alternative time windows (in minutes) with Bloomberg survey and ε is the path factor. To minimise 𝛿,𝑡 t being returns on policy day . The windows thus the impact of other significant macroeconomic events on δ ∈ {30,60} constructed span 30 minutes (i.e., 10 minutes before asset prices, changes are measured over a narrow window 𝑡 and 20 minutes after the policy announcement) and 60 around policy announcements (Gurkaynak et al., 2004). minutes (i.e., 15 minutes before and 45 minutes after) The estimated target and path factors on each policy around the policy announcement. The findings indicate announcement day around a 60-minute window for the that Sensex returns are affected significantly by the period January 2014-August 2024 encompassing 67 policy surprise in the future path of monetary policy (path factor), announcement dates, including 5 unscheduled ones, are and it is stronger for the 60-minute window vis-à-vis the presented in Chart IV.1.1.8 30 minutes window (Table IV.1.1). As expected, a positive To assess the relative importance of target and path factors path factor or an expected policy tightening in the future for movements in equity prices, BSE Sensex returns over leads to negative equity returns as equity markets price two different, but narrow, time windows are regressed on in changes in longer-term borrowing costs. The results, the target and path factors: (2) (Cont.) 𝑅𝛿,𝑡 = 𝛼 + 𝛽1𝑇𝐹𝛿,𝑡 + 𝛽2𝑃𝐹𝛿,𝑡 7 Assuming that changes in the OIS rates are in response to unanticipated changes in monetary policy and that other factors such as risk premia remain constant in these intraday windows. 8 Gupta et al., (2024) conducts a similar exercise on policy dates for the period June 2018-June 2022. 6655Monetary Policy Report October 2024 References Table IV.1.1: Monetary Policy Announcement Impact on BSE Sensex Anderson, M. (2010). Using intraday data to gauge financial market response to federal reserve and ECB Variables 30 minutes 60 minutes monetary policy decision. International Journal of Central Intercept -0.033 -0.032 Banking, 6(2), 107-116. (0.039) (0.062) Target Factor 0.192 0.727 Gupta, M., Pawar, A., Kumar, S., Borad, A. & Seet, S. (2024). (0.621) (1.230) Equity Markets and Monetary Policy Surprises (Working Path Factor -0.016* -0.034** Paper No. 3). Reserve Bank of India. (0.009) (0.015) Observations 67 67 Gurkaynak, R. S., Sack, B., & Swanson, E. T. (2004). Do Adjusted R2 0.041 0.138 actions speak louder than words? The response of asset Notes: a) Significance level: ‘***’ 0.01 (1%), ‘**’ 0.05 (5%), ‘*’ 0.1 (10%). prices to monetary policy actions and statements. Finance b) Newey-West standard errors are presented in parentheses. and Economics Discussion Series, 2004(66), 1–43. Source: RBI staff estimates. Lloyd, S. P. (2018). Overnight index swap market-based therefore, underscore the impact of central bank measures of monetary policy expectations. Staff Working communication on market movements and sentiments. Paper No. 709. equities continued to rally in September amid a US (Chart IV.13a). Amid bouts of volatility, India VIX Fed rate cut of 50 bps and reached new highs, with the averaged higher at around 14.8 during H1:2024-25 weight of Indian equities surpassing that of China in a than 13.2 during H2:2023-24 (Chart IV.13b). key global MSCI index. Foreign Portfolio Investment (FPI) flows remained Overall, the BSE Sensex gained 14.5 per cent during volatile in the early half of H1:2024-25, with FPIs H1:2024-25 to close at 84,300 at end-September 2024. turning net sellers during April and May 2024. The broader market indices continued to outperform Foreign investors, however, remained overall net the benchmark Sensex, with the BSE MidCap and the BSE SmallCap index increasing by 25.5 per cent buyers in equities during H1:2024-25. Support from and 32.4 per cent, respectively, during H1:2024-25 domestic institutional investors (DIIs), on the other Chart IV.13: Stock Market Performance in H1: 2024-25 Source: Bloomberg. 66Chapter IV Financial Markets and Liquidity Conditions Chart IV.14: Institutional Investments and Resource Mobilisation Note: IPO – Initial Public Offer, QIP – Qualified Institutional Placement, FPO – Follow On Public Offer Sources: Capitaline; NSDL; and SEBI. hand, remained robust. Overall, DIIs and FPIs were at 1.58 lakh crore during H1 (up to August 2024) as net buyers to the tune of 2.26 lakh crore and 0.82 against 1.32 lakh crore in H2:2023-24 (Chart IV.14b). ₹ lakh crore, respectively, in H1 (Chart IV.14a). In terms Of the total resource mobilisation from the primary ₹ ₹ ₹ of systematic investment plan (SIP) contributions market, SME companies mobilised 3,858 crores (up through mutual funds, monthly collections crossed to August 2024) through public issues. ₹ the 20,000 crore mark for the first time in April 2024, IV.1.5 Foreign Exchange Market followed by fresh highs in each of the subsequent ₹ months in H1 (up to August 2024). Primary market The Indian rupee (INR) traded in a range-bound resource mobilisation in equity markets was placed manner with a depreciating bias during the first half Chart IV.15: Indian Rupee and Volatility Sources: FBIL; Refinitiv Eikon; and Bloomberg. 6677Monetary Policy Report October 2024 of 2024-25 (Chart IV.15a). The US dollar remained Table IV.3: Nominal and Real Effective Exchange strong on the back of elevated US treasury yields Rate Indices (Trade-weighted) between April and mid-July 2024 but depreciated (Base: 2015-16 = 100) thereafter due to strong market expectations of a Appreciation (+) / Index: Depreciation (-) (Per cent) potential rate cut by the US Fed, which was eventually Item September 27, September 27, 2024, over corroborated by the 50 bps rate cut by the US Fed on 2024 (P) March (average) 2024 September 18. The unwinding of yen carry trade in 40-currency REER 104.7 0.1 early-August exacerbated volatility in global financial 40-currency NEER 90.2 -2.1 markets, albeit briefly. Overall, the volatility of the 6-currency REER 101.7 2.0 INR – measured by the 1-month at the money (ATM) 6-currency NEER 81.3 -16.4 option implied volatility – fell marginally to an average /US$ (September 30) 83.8 -0.9 P: Provisional. of 2.2 per cent during H1 from 2.4 per cent during ₹ Sources: RBI; and FBIL. H2:2023-24 (Chart IV.15b). Between end-March and end-September 2024, the but rose in Q2, particularly for longer maturities, INR depreciated by 0.5 per cent against the US dollar, due to increased expectations of a US rate cut. The although it outperformed several EME peer currencies 1-month forward premia averaged 1.18 per cent (Chart IV.16). during H1:2024-25, marginally higher than 1.13 per cent in H2:2023-24, while the 12-month premia rose In terms of the Reserve Bank’s 40-currency real effective exchange index, the INR appreciated by 0.1 to 1.84 per cent in H1:2024-25 from 1.72 per cent in per cent between March 2024 (average) and September H2:2023-24 (Chart IV.17). 27, 2024 (Table IV.3). A composite view of all market segments Forward premia remained stable in Q1:2024-25 suggest benign financial conditions in H1 (Box IV.2). Chart IV.16: Global Movement in Currencies Chart IV.17: Movements in Forward Premia Sources: FBIL; IMF; and Refinitiv Eikon. Source: Bloomberg. 68Chapter IV Financial Markets and Liquidity Conditions Box IV.2: Financial Conditions Index – A High-Frequency Approach A financial conditions index (FCI) is a summary measure Table IV.2.1: Variables for FCI that encapsulates the information content in a broad array of financial variables and helps to gauge the WAMMR spread over repo rate WAMMR volatility incipient stress in financial markets. Monetary policy Money Market Net LAF / NDTL actions impact financial conditions through channels of 3M CP (NBFC) over T-Bill monetary transmission although financial conditions Yield Curve level often change independently of policy decisions. The FCI G-sec Market Yield Curve slope is, thus, a valuable input for monetary policy in so far Yield Curve curvature as it measures the impact of financial variables on real AAA 3yr spread Corporate Bond AAA 5yr spread activity, over and above the direct effects of monetary Market AA 3yr spread policy (Hatzius et al., 2010). It can, therefore, serve as a AA 5yr spread guide on the effective stance of policy (Bowe et al., 2023). India US 10yr yield differential USD-INR 1M ATM volatility Forex Market An FCI for India is constructed by using twenty financial Currency return market indicators at daily frequency for the period January 1M forward premia 1, 2012 to September 30, 2024. The chosen indicators India VIX PE level relative to 2yr moving average represent five market segments, namely (i) the money Equity Market BSE Sensex return market; (ii) the G-sec market; (iii) the corporate bond BSE Mid-Cap return market; (iv) the forex market; and (v) the equity market BSE Small-Cap return (Table IV.2.1). The money market segment includes The FCI is computed using a dynamic factor model (DFM): indicators on liquidity conditions while the G-sec market segment is represented by latent factors viz., level, slope, (1) and curvature of the sovereign yield curve. The corporate 𝑋𝑡 = 𝜆(𝐿)𝑓𝑡 + 𝜉𝑡 bond market segment is captured through credit risk 𝑓w𝑡h =e r Ψe ( 𝐿)𝑓 i𝑡s-1 + th 𝜂e𝑡 vector of financial indicators, is the underlying common factor representing the financial indicators. Finally, indicators on return and volatility of 𝑋𝑡 𝑓t conditions index, and and are mean-zero serially currency and equities constitute the forex and equity uncorrelated idiosyncratic errors. market segments, respectively. All indicators are factored 𝜉𝑡 𝜂𝑡 into the index in a manner such that an increase in these The standardized FCI along with the contribution of its indicate a tightening of financial conditions. constituent blocks is presented in Chart IV.2.1. Chart IV.2.1: FCI and its Drivers Source: RBI staff estimates. (Cont.) 6699Monetary Policy Report October 2024 The estimated FCI closely tracks the evolution of financial withdrawal of accommodation. Congenial financial conditions in India over the years. The peaks in FCI are conditions during this period were mainly driven by associated with major events like the taper tantrum, stress stable forex market conditions and the buoyant equity in the NBFC sector during the Infrastructure Leasing and market, reflecting improved global investor confidence in Financial Services (IL&FS) episode and the COVID-19 India’s economic outlook. pandemic. The major drivers of FCI, however, vary across References: events. While the forex market was the key factor during the taper tantrum, domestic factors were the primary Bowe, F., Gerdrup, K.R., Maffei-Faccioli, N., and Olsen, H. drivers during the IL&FS and COVID-19 episodes. The (2023). A high-frequency financial conditions index for exceptionally easy financial condition in the aftermath of Norway. Staff Memo No. 1, Norges Bank. the pandemic was driven by all market segments. Hatzius, J., Hooper, P., Mishkin, F.S., Schoenholtz, K.L., Since mid-2023, financial conditions have remained and Watson, M.W. (2010). Financial Conditions Indexes: A benign even as the policy repo rate remained on pause Fresh Look After the Financial Crisis. NBER Working Paper at 6.5 per cent and the stance continued to focus on No. 16150 IV.1.6 Credit Market9 Across bank groups, credit growth of private sector banks (PVBs) remained higher (16.4 per cent) than Growth in bank credit remained strong in H1:2024- that of public sector banks (PSBs) (12.9 per cent), 25, albeit with a slowing momentum. Non food while foreign banks’ credit offtake picked up pace bank credit of scheduled commercial banks (SCBs) (Chart IV.19a). PSBs continued to account for the decelerated to 14.4 per cent (y-o-y) as on September largest share of incremental credit, although their 20, 2024 from 15.3 per cent a year ago (Chart IV.18). share declined vis-à-vis PVBs and foreign banks Chart IV.18: Non-food Credit Growth of SCBs (Chart IV.19b). From a sectoral perspective, the overall growth (y-o-y) in bank credit was primarily driven by personal loans and services, although their share in total incremental credit moderated in H1:2024-25 (up to August) vis-à- vis the same period of the previous year10. Credit growth to the agriculture sector remained in double digits. Industrial credit growth, which was tepid during H1:2023-24, recorded an uptick in H1:2024-25 (up to August). Credit to services and personal loans segments, however, moderated, reflecting the impact of the regulatory measures11 undertaken by the Reserve Bank in November 2023 (Chart IV.20a). The share of agriculture and industry in SCBs’ Source: RBI. incremental credit offtake rose to 16.1 per cent and 9 While overall bank credit and non-food credit data are based on Section-42 return (which covers all SCBs), sectoral non-food credit data are based on sector-wise and industry-wise bank credit (SIBC) return, which covers select banks accounting for about 95 per cent of total non-food credit extended by all SCBs. Data on bank credit exclude the impact of merger of a non-bank with a bank. 10 The sectoral credit growth (y-o-y) for May 2024 is based on 27 fortnights as against the usual 26 fortnights. 11 Risk weights on bank lending to NBFCs and retail loans excluding housing, education, vehicle loans, and loans against gold and gold jewellery were increased on November 16, 2023 (https://rbidocs.rbi.org.in/rdocs/notification/PDFs/REGULATORYMEASURES8785E7886A044B678FB8AF2C6C051807.PDF). 70Chapter IV Financial Markets and Liquidity Conditions Chart IV.19: Credit Flow across Bank Groups Source: RBI. 16.6 per cent, respectively, in August 2024 from 14.4 support from the Government through the price per cent and 9.6 per cent, respectively, in the previous support scheme (PSS) for pulses & oilseeds and market year. In contrast, the incremental share of services intervention scheme (MIS) for perishable agricultural and personal loans moderated over the same period commodities. (Chart IV.20b). Credit to industry grew by 9.8 per cent in August Credit to agriculture and allied activities registered 2024 from 5.3 per cent a year ago, primarily driven double digit growth, improving to 17.7 per cent (y-o-y) by a pickup in offtake to large industry (Chart IV.21a). in August 2024 from 16.5 per cent a year ago (Chart Higher credit expansion in micro, small and medium IV.20a), driven by favourable monsoon and continued industries further supported growth in this segment Chart IV.20: Sectoral Deployment of Bank Credit Source: RBI. 7711Monetary Policy Report October 2024 Chart IV.21: Bank Credit to Industry Sector Source: RBI. (Chart IV.21b). Among the major industrial sub-sectors, Increasing dependency of NBFCs on bank borrowings credit growth to chemicals and chemical products, triggered regulatory concerns. Similarly, certain food processing, infrastructure, and petroleum, coal components showed higher growth in the personal products and nuclear fuels accelerated in August 2024. loans segment, which led to concerns about incipient stress. To address the build-up of any potential Credit growth to services and personal loans segments at 15.6 per cent and 16.9 per cent, respectively, risk, the Reserve Bank tightened lending norms in in August 2024 displayed gradual moderation November 2023 as alluded to earlier. Consequently, (Chart IV.22a and IV.23a). Within the services sector, total consumer loan growth in the sub-segments NBFCs were the main driver of overall growth. where risk weights were increased, moderated to 13.9 Chart IV.22: Bank Credit to Services Sector Note: In the case of NBFCs, a few banks have reported prepayment/repayment of their advances from some HFCs/PFIs/NBFCs, which also contributed to the decline in growth. Source: RBI. 72Chapter IV Financial Markets and Liquidity Conditions Chart IV.23: Bank Credit in Personal Loans Segment Source: RBI. per cent while their share in incremental credit to The asset quality of SCBs improved during 2024- the sector declined to 29.7 per cent in August 2024 25 (up to June 2024), with the overall gross non- (Chart IV.23b). performing assets (NPA) ratio declining to 2.7 per cent in June 2024 from 3.7 per cent a year ago (Chart In tandem, growth in bank credit to NBFCs moderated IV.24a). Asset quality improved across all the major to 12.2 per cent, bringing down its share to 26.9 per sectors (Chart IV.24b). cent of incremental credit extended to services during the same period (Chart IV.22b). Growth in non-SLR12 investments of banks (comprising investments in CPs, bonds, debentures and shares of Chart IV.24: Stressed Assets and Non-Performing Assets of SCBs Source: RBI. 12 Statutory Liquidity Ratio 7733Monetary Policy Report October 2024 Chart IV.25: Non-SLR Investment and Adjusted Non-Food Credit Source: RBI. public and private corporates) increased to 4.8 per demand and time liabilities (NDTL), up from 8.6 per cent in H1:2024-25 from 4.1 per cent in H2:2023-24 cent at end-September 2023 (Chart IV.26). Excess SLR (Chart IV.25a). The growth in adjusted non-food credit holdings provide collateral buffers to banks for availing (i.e., non-food bank credit plus non-SLR investments funds under the LAF as well as wholesale funding in by banks) was marginally lower at 14.1 per cent in the TREPS and market repo segments. They are also a Q2:2024-25 as compared to 14.4 per cent in Q2:2023- component of the liquidity coverage ratio (LCR). 24 (Chart IV.25b). IV.2 Monetary Policy Transmission Excess holdings of SLR securities by SCBs as on Transmission to lending and deposit rates of banks September 6, 2024 were 8.8 per cent of their net continued in H1:2024-25, with the latter adjusting Chart IV.26: Excess SLR of Banks faster in the wake of persistent credit demand and the widening gap between credit and deposit growth. During H1:2024-25, the median 1-year marginal cost of funds based lending rate (MCLR) of SCBs increased by 10 bps, indicating a slightly higher cost of borrowing. During April-August 2024, the weighted average lending rates (WALRs) on fresh and outstanding rupee loans increased by 4 bps and 6 bps, respectively. In the current tightening cycle, i.e., May 2022 to August 2024, in which the policy repo rate was cumulatively increased by 250 bps, the WALR of SCBs on fresh and outstanding rupee loans increased by 190 bps and 119 bps, respectively. On the deposit side, the weighted average domestic * Data till September 6, 2024 Source: RBI. term deposit rates (WADTDRs) on outstanding rupee 74Chapter IV Financial Markets and Liquidity Conditions Table IV.4: Transmission from the Repo Rate to Banks’ Deposit and Lending Rates (Variation in basis points) Term Deposit Rates Lending Rates WADTDR- Period R Re ap teo WADTDR - Fresh Deposits Ou Dt es pta on sd iti sng EBLR 1-Yr. MCLR WALR - Fresh OuW tstA aL nR d- i ng (Median) Rupee Loans Retail Retail and Retail and Rupee Loans Deposits Bulk Deposits Bulk Deposits (1) (2) (3) (4) (5) (6) (7) (8) (9) Easing Phase -250 -209 -259 -188 -250 -155 -232 -150 Feb 2019 to Mar 2022 Tightening Period +250 186 243 190 250 170 190 119 May 2022 to Aug 2024* Of which Apr 2023 to Aug 2024* 0 12 -2 77 - 40 9 19 Apr 2024 to Aug 2024* 0 21 -16 4 - 10 4 6 Notes: Data on EBLR pertain to 32 domestic banks. *: Latest data on EBLR and MCLR pertain to September 2024. WALR: Weighted average lending rate; WADTDR: Weighted average domestic term deposit rate; MCLR: Marginal cost of funds-based lending rate; EBLR: External benchmark-based lending rate. Source: RBI. deposits of SCBs increased by 4 bps in H1:2024-25 Bank group-wise, the transmission to WALRs on fresh (up to August 2024); however, it moderated by 16 bps rupee loans of PSBs was higher than that of PVBs, for fresh deposits. Banks have increased their rates while it was lower for outstanding loans (Chart IV.27a). on fresh retail deposits by 21 bps during the same The lending rates of PVBs remained above those of period. The WADTDRs on fresh and outstanding PSBs (Chart IV.27b). The maximum pass-through to rupee deposits of SCBs increased by 243 bps and 190 lending rates was witnessed in the case of foreign bps, respectively, during May 2022 to August 2024 banks, reflecting their higher share of low-cost and (Table IV.4). wholesale deposits of lower maturity. Moreover, the Chart IV.27: Bank Group wise Transmission to Lending Rates Source: RBI. 7755Monetary Policy Report October 2024 Chart IV.28: Outstanding Floating Rate Rupee Loans of SCBs across Interest Rate Benchmarks Notes: 1. Data pertain to 73 scheduled commercial banks. 2. ‘Others’ include benchmark prime lending rate, base rate and other internal benchmarks. 3. ‘Other benchmarks’ include any other market interest rate published by FBIL. Source: RBI. higher share of external benchmark-based lending share of EBLR-linked loans is higher among private rate (EBLR)-linked loans in foreign banks further banks (Chart IV.28d). The persistence of loans linked facilitated monetary policy transmission13. to MCLR and other legacy rates – based on internal benchmarks and having longer reset periods – are The share of EBLR-linked loans in total outstanding impediments to faster monetary policy transmission. floating rate loans increased to 57.5 per cent at end- June 2024 from 56.6 per cent at end-March 2024. During May 2022 to August 2024, the transmission to Concomitantly, the share of MCLR-linked loans WALRs on fresh and outstanding loans has been broad- declined to 38.6 per cent from 39.2 per cent over the based across sectors (Chart IV.29a). The differential same period (Chart IV.28a,b). The increasing share of pace of transmission in various sectors is on account EBLR-linked loans with shorter reset periods aided of the proportion of credit portfolios linked to fixed transmission to WALRs of SCBs in the current tightening and floating interest rates in the particular sector cycle. There is still a significant proportion of loans and the varied spreads charged by banks. In the case linked to MCLR in the case of PSBs (Chart IV.28c). The of floating rate loans that are mandatorily linked to 13 The proportion of EBLR-linked loans for foreign banks was 90.1 per cent as at end-June 2024. 76Chapter IV Financial Markets and Liquidity Conditions Chart IV.29: Sector-wise Transmission to WALRs of Domestic Banks (May 2022 to August 2024) Source: RBI. EBLR, the WALRs on fresh loans of domestic banks The combination of sustained credit demand and increased by 210 bps for education loans, 197 bps for persistent gap between credit and deposit growth vehicle loans, 164 bps for housing loans and 160 bps prompted banks (especially PSBs) to increase their for MSME loans (Chart IV.29b). term deposit rates to bridge the funding gap (Chart IV.30a). Across bank groups, the pass-through to Banks have reduced their spreads (WALRs on WADTDRs on fresh and outstanding deposit rates was fresh floating rate rupee loans over the policy repo rate), which moderated the extent of transmission higher for PSBs than PVBs (Chart IV.30b). (Table IV.5). Despite deregulation of interest rates by the Reserve Bank in October 2011, savings bank deposit rates have Table IV.5: Spread of WALR (Fresh Loans) over remained mostly sticky and unresponsive to evolving the Repo Rate for the Loans linked to External macro-financial conditions (Chart IV.30c). Given that Benchmark savings deposit comprise about 30 per cent of total (Per cent) Sectors Apr-22 Aug-24 deposits, the overall transmission to deposit rates Public Private Domestic Public Private Domestic remains low if savings deposit rates remain immune sector sector banks sector sector banks to policy rate changes. Moreover. the decline in the banks banks banks banks share of current account and savings account (CASA) MSME Loans 4.27 3.93 4.04 3.18 3.13 3.14 Personal Loans deposits in total deposits, along with the higher Housing 2.91 3.32 3.21 2.11 2.44 2.35 increase in term deposit rates vis-a-vis lending rates Vehicle 3.37 4.39 3.55 2.62 3.86 3.02 have exerted downward pressure on the net interest Education 4.42 5.71 4.71 3.62 4.78 4.31 margins (NIMs) of banks (Chart IV.30d). Other personal 3.54 7.35 4.01 2.97 5.44 3.37 loans Since Q3:2022-23, interest rates on various small Note: Other personal loans include loans other than housing, vehicle, savings instruments have been cumulatively increased education and credit card loans. Sources: RBI; and RBI staff estimates. in the range of 70-250 bps by the GoI (Chart IV.31). 7777Monetary Policy Report October 2024 Chart IV.30: Deposit Rates and Bank’s Profitability Source: RBI. With these adjustments, the rates on most of the rates, except for those on public provident funds and instruments are now aligned with the formula-based post office recurring deposits. Competitive rates are now being offered on post office time deposits of Chart IV.31: Increase in Interest Rates on Small shorter tenor (Table IV.6). Savings Schemes (May 2022 to Sep 2024) IV.3 Liquidity Conditions and the Operating Procedure of Monetary Policy The Reserve Bank of India (RBI) Act, 1934 requires the RBI to place the operating procedure relating to the implementation of monetary policy and changes thereto from time to time, if any, in the public domain. During H1:2024-25, the monetary policy committee (MPC) kept the policy repo rate unchanged at 6.50 per cent and continued with the stance of withdrawal of accommodation to ensure that inflation progressively aligns to its target of 4 per cent, while supporting growth. In view of the changing liquidity dynamics, Sources: Government of India; and RBI. the Reserve Bank conducted two-way operations 78Chapter IV Financial Markets and Liquidity Conditions Table IV.6: Interest Rates on Small Savings Instruments – Q3:2024-25 Small Savings Schemes Maturity (years) Spread Average G-sec Formula based GoI Announced Difference (Percentage yield (%) of rate of Interest Rate of interest (Percentage point) $ corresponding (%) (applicable for Q3:2024-25 point) maturity for Q3: 2024-25) (in %) (Jun 2024-Aug 2024) (1) (2) (3) (4) (5) = (3) + (4) (6) (7) = (6) - (5) Savings Deposit - - - - 4.00 - Public Provident Fund 15 0.25 7.09 7.34 7.10 -0.24 Term Deposits 1 Year 1 0 6.81 6.81 6.90 0.09 2 Year 2 0 6.81 6.81 7.00 0.19 3 Year 3 0 6.82 6.82 7.10 0.28 5 Year 5 0.25 6.83 7.08 7.50 0.42 Recurring Deposit Account 5 0 6.82 6.82 6.70 -0.12 Monthly Income Scheme 5 0.25 6.79 7.04 7.40 0.36 Kisan Vikas Patra 115 Months# 0 7.09 7.09 7.50 0.41 NSC VIII issue 5 0.25 7.01 7.26 7.70 0.44 Senior Citizens Saving Scheme 5 1.00 6.83 7.83 8.20 0.37 Sukanya Samriddhi Account Scheme 21 0.75 7.09 7.84 8.20 0.36 $: Spreads for fixing small saving rates as per Government of India Press Release of February 2016. #: Current maturity is 115 months. Note: Compounding frequency varies across instruments. Sources: GoI; FBIL; and RBI staff estimates. under the LAF to ensure orderly evolution of financial (OMOs) under the NDS-OM14 in Q2. Consequently, markets. average daily net absorption under the LAF stood at 1.3 lakh crore in Q2 (Table IV.7). Drivers and Management of Liquidity During H1:2024-25, average daily net absorption ₹ System liquidity transited from deficit in H2:2023-24 under the LAF at 0.4 lakh crore was sharply in to surplus in H1:2024-25. Within H1, system liquidity contrast to an average daily net injection of 1.1 ₹ was in deficit in Q1 with seasonal expansion in lakh crore during H2:2023-24. Consequently, average ₹ currency in circulation (CiC), build-up of government borrowings under the MSF declined to 8,004 crore in cash balances, and the increase in excess cash reserve H1:2024-25 from 71,574 crore in H2:2023-24. Of the ₹ ratio (CRR) balances held by banks. As a result, average average total absorption under the LAF, placement ₹ daily net injection under the LAF (including MSF) of funds under the SDF was 0.84 lakh crore (73.2 per cent), while the remaining was absorbed through stood at 0.5 lakh crore in Q1:2024-25. The liquidity ₹ variable rate reverse repo (VRRR) auctions during H1. dynamics changed in Q2 with the return of currency ₹ to the banking system, the Reserve Bank’s forex The Reserve Bank remained nimble and flexible purchases and the pick-up in government spending in liquidity management and conducted two-way after the elections. The Reserve Bank modulated operations during H1 in view of the shifting liquidity excess liquidity through open market operations dynamics. With system liquidity remaining in surplus 14 Negotiated Dealing System - Order Matching. 7799Monetary Policy Report October 2024 Table IV.7: Liquidity – Key Drivers and Management ( crore) 2023-24 2024-25 ₹ Q1 Q2 H1 Q1 Q2 H1 Drivers (i) CiC [withdrawal (-) /return (+)] 18,103 71,253 89,356 -47,264 80,820 33,556 (ii) Net Forex Purchases (+)/ Sales (-) 1,60,738 -16,071 1,44,667 -13,016 83,418 70,402 (iii) GoI Cash Balances [build-up (-) / drawdown (+)] -2,37,937 -1,79,913 -4,17,850 -97,774 -52,720 -1,50,494 (iv) Excess Reserves [build-up (-) / drawdown (+)] -31,485 -3,440 -34,925 -58,523 21,755 -36,768 Management (i) Net OMO Purchases (+)/ Sales (-) 0 -8,480 -8,480 0 -24,040 -24,040 (ii) Required Reserves [including both change in NDTL and CRR] -33,712 - 1,01,508 -1,35,220 - 30,413 - 25,200 -55,613 Memo Item Net Absorption (+)/ Injection (-) as at end-period 1,29,194 -40,636 -40,636 37,004 1,54,395 1,54,395 CiC: Currency in Circulation. GoI: Government of India Note: (+) / (-) sign suggests accretion/depletion in banking system liquidity. Data pertain to the last Friday of the respective period. Source: RBI. during April 2024 (up to April 19), the Reserve Bank lakh crore into the system during the second half of conducted one main and seven fine-tuning VRRR September to ease liquidity conditions. auctions (1-3 days maturity), cumulatively mopping The fine-tuning VRRR auctions, on average, elicited up 2.3 lakh crore from the banking system. As better response from the banks than the fortnightly liquidity turned into deficit since the latter half of main operations in H1.16 Given the tepid response of ₹ April, five main and 17 fine-tuning variable rate repo (VRR) auctions were conducted, cumulatively Chart IV.32: Liquidity Operations injecting 15.5 lakh crore into the system to ease liquidity tightness in Q1:2024-2515. A 3-day VRR ₹ auction was conducted on June 28 (Reporting Friday) instead of the main operation as liquidity conditions were expected to improve significantly in the near term. As systemic liquidity turned into surplus at the beginning of July, the Reserve Bank switched to variable rate reverse repo (VRRR) auctions to absorb surplus liquidity. Overall, 49 VRRR auctions – 5 main and 44 fine-tuning operations of maturities ranging 1-7 days – were conducted during Q2 to absorb surplus liquidity (Chart IV.32). As liquidity turned into deficit in the latter half of September, the Reserve Bank conducted one main and 3 fine- Source: RBI. tuning VRR operations, cumulatively injecting 2.1 ₹ 15 During this period, 3 fine-tuning VRRR operations were conducted on May 6 and June 4, cumulatively absorbing liquidity to the tune 0.7 lakh crore. 16 The average bid-offer ratio of fine-tuning auctions was 0.48 as compared to 0.17 for the fortnightly main auctions. 80Chapter IV Financial Markets and Liquidity Conditions accelerated to 5.7 per cent in September 2024 from Table IV.8: Banking and Monetary Aggregates 4.1 per cent at end-March 2024. Money supply (M3) (y-o-y growth, per cent) growth decelerated to 10.8 per cent (y-o-y) as on Indicator March March June September 2023 2024 2024 2024 September 20, 2024, from 11.2 per cent in end-March Reserve money 10.0 6.7 7.4 4.7 2024 (Table IV.8). (Adjusted for CRR changes) (7.6) (6.7) (7.4) (6.8) IV.4 Conclusion Broad money (M3) 9.0 11.2 9.7 10.8 Currency in circulation 7.8 4.1 6.0 5.7 In contrast to volatile global financial markets, Aggregate deposits 9.6 12.9 10.6 12.0 domestic market conditions remained stable in Demand deposits 5.2 12.1 6.2 13.3 H1:2024-25. Money market rates evolved in tune with Time deposits 10.2 13.7 11.8 11.3 liquidity shifts, consistent with the monetary policy Bank credit 15.0 16.3 13.9 14.4 stance. Domestic long-term bond yields eased amidst Note: Data is as on last reporting fortnight of the quarter. Data on broad money, deposits and credit growth exclude the impact of merger of a bank an improving inflationary outlook and positive global with a non-bank. sentiment on India’s prospects. Equity market scaled Source: RBI. new highs, mainly supported by domestic investors. banks in parking surplus liquidity for longer tenors The INR traded with a depreciating bias but remained as reflected in the lower bid-offer ratio in the main among the least volatile EME currencies during H1. VRRR operations, the Reserve Bank conducted more Monetary transmission continued with credit growth fine-tuning operations in Q2. continuing to outpace deposit expansion. Going As on September 20, 2024, reserve money (RM) forward, the Reserve Bank will remain agile and expanded by 6.8 per cent (y-o-y) (adjusted for the nimble in conducting market operations to ensure first-round impact of the change in CRR) as against financial stability while providing liquidity to meet 6.7 per cent at end-March 2024. The growth in CiC the productive requirements of the economy. 8811Monetary Policy Report October 2024 V. External Environment Global growth remains resilient. Headline inflation decelerated at a sluggish pace as sticky services prices hindered strong disinflation in goods. Most central banks tread the path of monetary policy normalisation but with measured cuts and cautious pace, while others retain their restrictive stance. Fluctuating perceptions on the monetary policy trajectory imparted volatility to global financial markets. Stubborn services inflation, high public debt, geopolitical risks, potential escalation of trade tensions, and extreme weather events pose downside risks to the global growth outlook. Global economic activity remains resilient. World indicators for Q3:2024 point to faltering momentum trade has firmed up, propelled by strong exports in manufacturing but a durable expansion in services from Asia. Both headline and core inflation (headline sector activity. In its World Economic Outlook (WEO) excluding food and energy) continue to decelerate, update of July 2024, the International Monetary albeit at a sluggish pace, with strong disinflation in Fund (IMF) retained global growth projections at 3.2 goods hindered by persistence of higher-than-average per cent for 2024 while increasing it to 3.3 per cent services inflation. With inflation still above target for for 2025.1 some inflation targeting advanced economies (AEs), Amongst the AEs, the US economy grew by 3.0 per cent central banks remain cautious while unwinding their (quarter-on-quarter seasonally adjusted annualised restrictive stance. Some emerging market economies rates (q-o-q, saar)) in Q2:2024, faster than in Q1 (1.6 (EMEs), on the other hand, that had initiated pre- per cent) (Table V.1). This improvement was driven emptive tightening to curb inflation persistence at by consumer spending, private inventory investment, elevated levels have continued to normalise their and non-residential fixed investment, while imports monetary policies while others retain policy rates at restrictive levels. Global financial markets remain also increased. Labour market conditions have been volatile in response to fluctuating perceptions on easing, with the unemployment rate picking up to the monetary policy trajectory and how it impacts 4.1 per cent in September (3.8 per cent in March). the growth-inflation trade-off. Equity markets have The US composite Standard and Poor's (S&P) global broadly gained notwithstanding intermittent bouts of purchasing managers’ index (PMI) was robust at 54.0 sharp spikes in volatility. Sovereign bond yields have in September 2024, though increasingly uneven as softened, while the US dollar has pared strength since services activity exhibited solid expansion while April 2024. Off-late, however, both sovereign bond manufacturing output declined. yields and US dollar index have inched up, reversing Real GDP growth in the euro area decelerated in Q2 its earlier trend. Risks to the global growth outlook to 0.8 per cent (q-o-q, saar) from 1.3 per cent in Q1 remain broadly balanced. due to decline in gross fixed capital formation. Labour V.1 Global Economic Conditions markets remained resilient, with the unemployment In 2024 so far, global economic activity has rate at 6.4 per cent in August, its lowest level since remained stable despite tight financial conditions the start of the euro. The Eurozone composite PMI and persistent geopolitical risks. High frequency hit a seven-month low of 49.6 in September from 1 The Organisation for Economic Co-operation and Development (OECD) in its Interim Economic Outlook (September 2024) revised up global growth forecast for 2024 by 10 bps to 3.2 per cent from May 2024 projections and retained it at 3.2 per cent for 2025. 82Chapter V External Environment slower upturns reflected in both the sectors. Japan’s Table V.1: Real GDP Growth (Per cent) GDP rebounded strongly and grew by 2.9 per cent in Q2:2024 (q-o-q, saar) vis-à-vis a contraction of 2.4 per Country Q3- Q4- Q1- Q2- 2023 2024 2025 2023 2023 2024 2024 (P) (P) cent in Q1, driven by robust private consumption Quarter-on-quarter, seasonally adjusted, annualised rate (q-o-q, saar) and capital expenditure. The composite PMI (au Canada -0.3 0.1 1.8 2.1 Jibun Bank) remained elevated at 52.0 in September Euro area 0.2 0.3 1.3 0.8 following a 15-month high of 52.9 in August, driven Japan -4.3 0.2 -2.4 2.9 South Korea 3.0 1.8 5.3 -0.9 by resilient services activity. UK -0.4 -1.3 2.8 1.8 Amongst EMEs, China’s real GDP moderated to 4.7 US 4.4 3.2 1.6 3.0 per cent (y-o-y) in Q2:2024 from 5.3 per cent in Q1, Year-on-year Advanced Economies amidst continued downturn in the real estate sector Canada 0.7 1.0 0.6 0.9 1.2 1.3 2.4 and tepid consumer demand. Secondary and tertiary Euro area 0.0 0.2 0.5 0.6 0.5 0.9 1.5 industries also witnessed a slowdown in the second Japan 1.3 0.9 -0.9 -1.0 1.9 0.7 1.0 quarter. Nonetheless, the economy grew by 5.0 per South Korea 1.4 2.1 3.3 2.3 1.4 2.5 2.2 cent in the first half of 2024 – propelled by monetary UK 0.3 -0.3 0.3 0.7 0.1 0.7 1.5 US 3.2 3.2 2.9 3.0 2.5 2.6 1.9 easing and regulatory relaxations for the real estate Emerging Market Economies sector – meeting the official target of 5.0 per cent for Brazil 2.0 2.1 2.5 3.3 2.9 2.1 2.4 2024 so far. The composite PMI (Caixin) posted 50.3 in China 4.9 5.2 5.3 4.7 5.2 5.0 4.5 September, down from 51.2 in August due to slower India 8.1 8.6 7.8 6.7 8.2 7.0 6.5 expansions in both manufacturing and services Indonesia 4.9 5.0 5.1 5.1 5.0 5.0 5.1 Philippines 6.0 5.5 5.8 6.3 5.5 6.0 6.2 sectors. Russia 5.7 4.9 5.4 4.1 3.6 3.2 1.5 Among other major EMEs, Brazil’s GDP growth South Africa -0.9 1.4 0.5 0.3 0.7 0.9 1.2 accelerated to 3.3 per cent (y-o-y) in Q2:2024 vis-à- Thailand 1.4 1.7 1.6 2.3 1.9 2.9 3.1 Memo: vis 2.5 per cent in Q1, driven by expansion in the World 2023 2024 (P) 2025 (P) services and industrial sectors. The labour market, Year-on-year however, remained tight as the unemployment rate Output 3.3 3.2 3.3 continued to decline to 6.6 per cent in August 2024, Trade volume 0.8 3.1 3.4 its lowest level since 2014. The composite PMI was up P: Projection. Note: India’s data correspond to fiscal year (April-March); e.g., 2024 from an eight-month low of 52.9 in August to 55.2 in pertains to April 2024-March 2025. September due to quicker upturn in services activity Sources: Official statistical agencies; Bloomberg; IMF WEO Update, July and a renewed expansion in factory production. The 2024 and RBI staff estimates. South African economy grew at a tardy pace of 0.3 per 51.0 in August as downturn in manufacturing output cent (y-o-y) in Q2:2024 (0.5 per cent in Q1) as financial deepened amidst a sustained reduction in new orders. industry expansion was offset by the decline in the GDP growth in the UK, despite moderating from 2.8 per transport, storage and communication industry. cent (q-o-q, saar) in Q1:2024, remained resilient at 1.8 The composite PMI for South Africa rose from 50.5 per cent in Q2 supported by increases in gross capital in August to 51.0 in September signalling improved formation, government consumption and household demand conditions. The Russian economy grew by 4.1 spending. The unemployment rate increased to per cent (y-o-y) in Q2:2024 (5.4 per cent in Q1), partly 4.3 per cent in April-July 2024 from the average of driven by higher military and defence spending. The 4.0 per cent in 2023. The UK composite PMI posted composite PMI, however, posted 49.4 in September, 52.6 in September, down from 53.8 in August with down from 52.1 in August. 8833Monetary Policy Report October 2024 The ASEAN2 economies recorded resilient growth Turning to high frequency indicators, the OECD in Q2:2024 amidst higher new orders and increased composite leading indicators (CLIs) for September activity. Southeast Asian economies are projected to 2024 showed that most economies remained above grow at a robust pace3, driven by improved domestic the long-term trend (Chart V.1a). The global composite and external demand conditions, stable prices, and PMI remained in expansion zone for the eleventh increased tourism-related activities. In Q3:2024 so consecutive month in September at 52.0 as strong far, growth has decelerated marginally but remains expansion in the services sector offset weakness in healthy due to positive sentiments on future output manufacturing (Chart V.1b). The global manufacturing amidst persistent price pressures. PMI, however, plunged to an eleven-month low of 48.8 in September as output, new orders and employment Among the BRICS economies barring South Africa, contracted. GDP growth for 2024 is projected to moderate marginally (Table V.2). The inflation scenario in Global merchandise trade volume grew for the these countries is expected to improve in 2024 for fourth consecutive month in July 2024, recording all, barring Russia where inflation has risen due to an expansion of 1.7 per cent (y-o-y). EMEs remained demand-supply imbalance. China is facing weak the major driver for the sixth consecutive quarter in rise in prices amidst a property slump and subdued Q2:2024, while trade volume continued to contract in consumer confidence. AEs (Chart V.2a). In July 2024, however, trade volume Table V.2: Select Macroeconomic Indicators for BRICS Real GDP growth rate Country 2023 2024(P) 2025(P) General Government Country 2023 2024(P) 2025(P) (y-o-y, per cent) gross debt (per cent Brazil 2.9 2.1 2.4 Brazil 84.7 86.7 89.3 of GDP)# Russia 3.6 3.2 1.5 Russia 19.7 20.8 21.9 India 8.2 7.0 6.5 India 82.7 82.5 81.8 China 5.2 5.0 4.5 China 83.6 88.6 93.0 South Africa 0.7 0.9 1.2 South Africa 73.9 75.4 77.9 CPI inflation rate Country 2023 2024(P) 2025(P) Current account Country 2023 2024(P) 2025(P) (y-o-y, per cent) balance (per cent of Brazil 4.6 4.1 3.0 Brazil -1.3 -1.4 -1.5 GDP) Russia 5.9 6.9 4.5 Russia 2.5 2.7 2.7 India 5.7 4.6 4.2 India -1.2 -1.4 -1.6 China 0.2 1.0 2.0 China 1.5 1.3 1.4 South Africa 5.9 4.9 4.5 South Africa -1.6 -1.8 -1.9 General Government Country 2023 2024(P) 2025(P) Forex reserves* Country 2022 2023 2024 net lending/ (in US$ billion) Brazil -7.9 -6.3 -5.5 Brazil 324.7 355.0 369.2 borrowing (per cent Russia -2.3 -1.9 -1.2 Russia 582.0 598.6 602.0 of GDP) India -8.6 -7.8 -7.6 India 562.7 622.5 704.9 China -7.1 -7.4 -7.6 China 3466,8 3610.0 3695.3 South Africa -6.0 -6.1 -6.3 South Africa 60.6 62.5 63.2 P: Projection. *: Forex reserves for 2024 pertain to August 2024 for all countries except for Russia (July 2024) and India (September 2024). #: Gross debt refers to the nonfinancial public sector, excluding Eletrobras and Petrobras, and includes sovereign debt held by the central bank. Note: India’s data correspond to fiscal year (April-March) except data on forex reserves which are as per calendar year. Sources: Official statistical agencies; WEO April 2024 database and July 2024 Update, IMF; and International Reserve and Foreign Currency Liquidity (IRFCL), IMF; and RBI. 2 Association of Southeast Asian Nations (ASEAN) includes Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, and Vietnam. 3 As per Asian Development Bank’s (ADB) Asian Development Outlook July 2024, Southeast Asian economies are projected to grow at a robust pace of 4.6 per cent in 2024 from 4.1 per cent in 2023. 84Chapter V External Environment Chart V.1: Survey Indicators Note: For PMI indices a reading above 50 indicates an overall increase compared to the previous month, and below 50 an overall decrease. The indices are seasonally adjusted. Sources: OECD; and Bloomberg. marginally revived in AEs. The Freightos Baltic Global in freight costs and an uptick in war-risk premia. In Index – the global ocean freight container pricing index September, however, the Freightos Baltic Global Index that measures 40-feet container prices – remained fell on m-o-m basis as demand moderated. Global trade elevated on y-o-y basis in September 2024 as attacks on value continued to expand in Q1:2024, with around 1 commercial shipping continued in the Red Sea trade per cent growth in merchandise trade (q-o-q) on the route (Chart V.2b). These attacks necessitated rerouting back of higher exports from China, India, and the of maritime trade from the Suez Canal to around the US.4 Trade in green energy and Artificial Intelligence Cape of Good Hope, leading to longer transit time, rise related products increased strongly in Q1. The latest Chart V.2: World Trade Volume Sources: CPB Netherlands; Refinitiv Eikon; and RBI staff estimates. 4 Global Trade Update, July 2024, UNCTAD. 8855Monetary Policy Report October 2024 WTO trade barometer (September 2024) indicates that end of the month and early June due to a significant global merchandise trade volume continued to grow drop in crude oil prices. Prices softened by 0.6 per in Q3:2024. The global trade outlook for 2024 remains cent (q-o-q) in Q3 due to moderating energy and metal positive; however, persistent geopolitical tensions, prices amidst weak demand from China (Chart V.3a). rising shipping costs and emerging industrial policies According to the Food and Agriculture Organization could impact trade patterns. According to the IMF's (FAO), global food prices edged up by 2.0 per cent WEO update of July 2024, global trade volume is (q-o-q) in Q2 and by 1.4 per cent in Q3, primarily due estimated to grow by 3.1 per cent and 3.4 per cent in to increase in the prices of vegetable oil, dairy and 2024 and 2025, respectively, with faster expansion in meat, though partly offset by decline in sugar and trade in emerging market and developing economies cereals prices (Chart V.3b). (EMDEs). Crude oil prices have moderated since the April 2024 V.2 Commodity Prices and Inflation MPR. Brent prices hovered above US$ 90 per barrel in In Q2:2024, global commodity prices as measured the first half of April following heightened geopolitical by the Bloomberg commodity price index remained tensions, but corrected over the rest of the period in volatile but maintained the levels attained in Q1. Q2 (till early June) in the wake of weak demand and Gains recorded in May were corrected towards the increased oil inventories. Crude oil prices fell to a low Chart V.3: Commodity Prices Sources: FAO; World Bank; Bloomberg; and PPAC, Ministry of Petroleum & Natural Gas, GoI. 86Chapter V External Environment of US$ 76 per barrel in early June after the meeting record highs buoyed by improved odds of the US Fed’s of OPEC+, wherein eight members agreed to reverse rate cut, renewed weakening of the US dollar and safe some “voluntary” cuts from October 2024.5 Thereafter, haven flight (Chart V.3d). with escalation of geopolitical tensions and larger Consumer Price Inflation than expected decline in US crude oil inventory, Consumer price inflation grudgingly eased further prices rose for a short while before again moderating as sticky services prices posed a drag on the pace in July over demand concerns, fuelled by lower-than- of disinflation. Nonetheless, inflation is already expected Chinese GDP growth and signs of cooling close to pre-pandemic levels for the median EMDEs US labour market. Crude prices firmed up in August owing to declining energy prices.6 Stronger nominal with tensions escalating in the Middle East, however, wage growth in some countries and escalating it began to soften in early September, prompting the postponement of the scheduled unwinding of the Table V.3: Consumer Price Inflation “voluntary” production cuts by eight OPEC+ members (Y-o-y, Per cent) from October to December 2024. Notwithstanding the Country Inflation Q3: Q4: Q1: Q2: Jul- Aug- Sep- Target 2023 2023 2024 2024 24 24 24 announcement, prices dropped below $70 per barrel Advanced Economies on September 10 – the first time since December Canada 2.0 ± 1.0 3.7 3.2 2.9 2.8 2.5 2.0 2021 – but recouped some losses thereafter. Natural Euro area 2.0 4.9 2.7 2.6 2.5 2.6 2.2 1.8 gas prices (according to the World Bank’s natural gas Japan 2.0 3.0 2.6 2.5 2.4 2.7 2.8 South Korea 2.0 3.2 3.4 3.0 2.7 2.6 2.0 1.6 index) increased in Q2 and Q3 due to unplanned UK 2.0 6.7 4.2 3.5 2.1 2.2 2.2 outages in Europe and increased demand for power US 3.5 3.2 3.3 3.2 2.9 2.5 generation in the US (Chart V.3c). (2.0) (3.4) (2.8) (2.7) (2.6) (2.5) (2.2) Emerging Market Economies Base metal prices peaked in May, fuelled by economic Brazil 3.0 ± 1.5 4.6 4.7 4.3 4.0 4.5 4.2 stimulus undertaken by China, the largest consumer Russia 4.0 5.2 7.2 7.6 8.2 9.1 9.1 of base metals, but corrected later over a muted India 4.0 ± 2.0 6.4 5.4 5.0 4.9 3.6 3.7 demand outlook. Overall, the prices of most base China -0.1 -0.3 0.0 0.3 0.5 0.6 South Africa 3.0-6.0 5.0 5.5 5.4 5.2 4.6 4.4 metals firmed up in Q2 and continued to rise in Q3 as Mexico 3.0 ± 1.0 4.6 4.4 4.6 4.8 5.6 5.0 positive sentiments from Chinese stimulus measures Indonesia 2.5 ± 1.0 3.0 2.7 2.8 2.8 2.1 2.1 1.8 overwhelmed negative sentiments emanating from Philippines 3.0 ± 1.0 5.4 4.3 3.3 3.8 4.4 3.3 1.9 muted demand outlook. Gold prices (q-o-q) rallied Thailand 1.0-3.0 0.5 -0.5 -0.8 0.8 0.8 0.4 0.6 in Q2 and Q3 by 5.5 per cent and 13.9 per cent, Turkey 5.0 ± 2.0 56.1 62.7 66.8 72.3 61.8 52.0 49.4 Memo: respectively, with prices surpassing their record highs 2022 2023 2024(P) 2025(P) in every successive month. Yellow metal prices surged World consumer price inflation 8.7 6.7 5.9 4.4 in April over a potential escalation in geopolitical P: Projection. tensions that triggered safe-haven demand. Prices Notes: 1. Japan's inflation pertains to CPI inflation in all items less fresh food - the Bank of Japan's target measure. moderated briefly as tensions eased but firmed up 2. Figures in the parentheses for US are year-on-year change in again in May above April levels due to weakening US personal consumption expenditure (PCE) price index. 3. Brazil’s inflation target for 2024 is 3.0 ± 1.5 per cent and was dollar and softening treasury yields. Prices corrected 3.25 ± 1.5 per cent for 2023. in late May and June over weak seasonal demand and 4. Indonesia’s inflation target for 2024 is 2.5 ± 1.5 per cent and was 3.0 ± 1.5 per cent for 2023. a stronger US dollar, but rebounded in Q3 to touch Sources: Central bank websites; IMF; and Bloomberg. 5 Voluntary cuts, representing 2.2 million barrels per day, introduced in January, and scheduled to end in June were extended till September. The same were announced to be unwound gradually over the following 12 months beginning in October. However, besides unwinding of these “voluntary” cuts, OPEC+ also announced extension of deep cuts in oil production to support prices till the end of 2025. 6 As per IMF's WEO Update released on July 16, 2024. 8877Monetary Policy Report October 2024 trade tensions pose upside risks to the disinflation from 3.0 per cent to 2.7 per cent over the same period momentum, causing monetary policy to remain (Chart V.4b). restrictive. Notwithstanding the decline, inflation still In the Euro area, CPI inflation moderated from 2.4 ranges above the target in some inflation-targeting per cent in April to 1.8 per cent in September. Core economies. According to the IMF's WEO Update, July inflation (inflation excluding energy, food, alcohol, and 2024, global inflation is projected to fall from 6.7 per tobacco) remained stable at 2.7 per cent in September cent in 2023 to 5.9 per cent in 2024 and further to 4.4 (same as in April), with a mild uptick during May- per cent in 2025 (Table V.3). August. In the UK, CPI headline inflation decelerated In the US, headline and core CPI inflation (y-o-y) sharply by 100 bps from 3.2 per cent in March to 2.2 decelerated from 3.5 per cent and 3.8 per cent, per cent in August, with core inflation declining from respectively, in March 2024 to 2.5 per cent and 3.2 4.2 per cent to 3.6 per cent. In Japan, CPI inflation per cent, respectively, in August. Inflation, in terms (all items less fresh food), the Bank of Japan (BoJ)’s of the personal consumption expenditure (PCE) price inflation target metric, eased briefly during March index – the Fed’s preferred measure – softened at a and April but started firming up since May. In August, tardy pace from 2.8 per cent in March to 2.2 per cent inflation at 2.8 per cent was well above the BoJ’s target in August (Chart V.4a), while core PCE inflation eased of 2 per cent. Core inflation (inflation excluding both Chart V.4: CPI Inflation (y-o-y) – Select Economies Notes: 1. For India, core CPI, i.e., CPI excluding food and fuel is worked out by eliminating the groups 'food and beverages' and 'fuel and light' from the headline CPI. 2. Japan's data in Chart V.4a refers to CPI inflation in all items less fresh food – the Bank of Japan's target measure, while data in Chart V.4b refers to CPI inflation in all items less fresh food and energy. Sources: Official statistical agencies; Bloomberg; and RBI staff estimates. 88Chapter V External Environment fresh food and energy), however, declined to 2.0 per V.3 Monetary Policy Stance cent in August from 2.4 per cent in April. Following the most aggressive and highly Amongst major EMEs, CPI inflation edged up in Brazil synchronised monetary policy tightening to counter to 4.2 per cent in August from 3.9 per cent in March multi-decadal high inflation in 2022-23, the strength 2024 (Chart V.4c). In Russia, it accelerated from 7.7 and credibility of central bank policies were tested per cent to 9.1 per cent over the same period due to as they tried to curb inflation without hampering western sanctions and an overheating economy. In growth, necessitating a revamp of the monetary policy South Africa, however, CPI inflation receded to 4.4 operating frameworks of some countries in the context per cent in August from 5.3 per cent in March. China of changing dynamics of policy trade-offs (Box V.1). In recorded positive inflation during March (0.1 per 2024, particularly during Q2 and Q3, monetary policy cent) to August (0.6 per cent) after it exited deflation cycles diverged as central banks across AEs and EMEs in February. Similar to AEs, core inflation is also responded to their own evolving growth-inflation receding, albeit grudgingly in EMEs (Chart V.4d). dynamics. While continuing to emphasise on caution Box V.1: Recent Changes in Global Monetary Policy Operating Frameworks: Response to Evolving Macro-Economic Developments While successfully navigating through the two black swan to the ECB, the RBA also planned to shift from a system events of the COVID-19 pandemic and the conflict in of excess to ample reserves in April 2024 (Kent, 2024). Europe, central banks worldwide had to quickly change According to the RBA, the move towards ample reserves, gears from providing large-scale stimulus that resuscitated that lies somewhere between the current ‘floor’ system economic activity to battling decadal-high inflation to with excess reserves and the pre-pandemic ‘corridor’ restore price stability. This prompted central banks to system with scarce reserves, eliminates (i) the need for undertake synchronised and aggressive interest rate hikes precise estimation of demand for reserves; (ii) minimises in decades accompanied by ultra-hawkish stances even as risk of volatile money markets; and (iii) is more resilient they started to taper their bloated balance sheets. to future balance sheet expansions during periods of financial stress. Monetary policy operating frameworks underwent significant refinements in two major systemic countries There are also instances of countries shifting to simpler – the European Central Bank (ECB) and the Reserve mandates for monetary policy for better management Bank of Australia (RBA). The ECB, faced with mounting of trade-offs. In February 2024, the RBA announced a post-pandemic inflation pressures, recognised the switch towards a dual mandate of price stability and full imperative of moving from abundant excess liquidity to employment with the clarification that, in practice, the one of less ample liquidity. In response, it announced a dual mandate is not a substantial departure from the new operational framework effective September 2024, status quo (PoA, 2024). In this regard, the deleted ‘third wherein the main refinancing operations (MRO) rate is goal’ of contributing to Australian people’s economic adjusted and anchored at 15 bps (as opposed to 50 bps prosperity and welfare will henceforth be an “overarching earlier) above the deposit facility rate (DFR) while the objective”, rather than a policy objective for monetary rate on marginal lending facility (MLF) remains at 25 bps policy. On a similar but more focussed move, the Reserve above the MRO rate (EP, 2024). This adjustment would Bank of New Zealand (RBNZ) highlighted the necessity for retain the asymmetric corridor but narrow the corridor a more precise and focused monetary policy target in June width to 40 bps from 75 bps, which would deter upward 2023. Recognising that the shift to a dual mandate in 2018 deviations and contain volatility as rate gets anchored was a mistake, it recommended a shift back to the single closer to the DFR (Chart V.1.1) (ECB, 2024).7 Analogous mandate in order to remain focussed on price stability (Contd.) 7 Additionally, two new instruments – a structural portfolio of assets and long-term refinancing operations – will be introduced going forward for ECB. 8899Monetary Policy Report October 2024 Chart V.1.1: ECB’s Operating Framework Source: European Central Bank. and enhance its policy credibility. The RBNZ amended decades, despite undertaking large scale monetary the Remit for the Monetary Policy Committee (MPC) in stimulus through Quantitative and Qualitative Monetary December 2023, recommending that the MPC remain Easing (QQE) along with Yield Curve Control (YCC). The solely focussed on achieving an inflation target of 1-3 per surge in inflation led to a rise in inflation expectations cent over the medium-term, with added emphasis on the and, therefore, the BoJ made a pivotal decision to exit its 2 per cent mid-point (RBNZ, 2023). negative interest rate policy in March 2024, discontinuing In the case of Japan, the pandemic served as a catalyst QQE with YCC (Chart V.1.2) (Kazuo, 2024). It removed the to emerge from the deflationary environment of several long-standing target of controlling the 10-year Japanese Chart V.1.2: Japan’s Operating Framework Source: Bank of Japan. (Contd.) 90Chapter V External Environment Government Bonds (JGBs) rate and started targeting the and consequentially, the roles of other rates on monetary uncollateralised overnight call rate. It also embarked on policy instruments with different tenures may soften. It tapering of the bond buying programme in a predictable also pointed out that the existing corridor of the standing manner. lending facility (SLF) acting as the ceiling and the rate on excess reserves (ERR) being the floor is relatively wide As countries prioritise inflation control, the role of central and may be narrowed, going forward. PBOC announced bank credibility and transparent communication gains a new cash management tool of temporary overnight prominence. With a view towards enhancing transparency repo (ORR) and reverse repo operations (ORRR), with the and ensuring effective policy communication, the interest rates fixed at the seven-day repo rate minus 20 People's Bank of China (PBoC) announced changes in bps and plus 50 bps, respectively (Chart V.1.3). The PBoC its monetary policy operating framework in June 2024 also intends to expand its policy toolkit by including and placed greater emphasis on price-based regulatory the purchase and sale of China government bonds in measures involving interest rates (Gongsheng, 2024). The the secondary market. Going ahead, the changes in the PBoC indicated that the seven-day reverse repo rate will framework will be tested and reviewed in response to be the central bank’s main short-term operational rate evolving macro-economic developments. Chart V.1.3: China’s Operating Framework Source: The People’s Bank of China. References: 1. European Central Bank (2024), Statement by the Governing Council, March 13. 2. European Parliament (2024), Briefing, A new operational framework for the European Central Bank, May 22. 3. Gongsheng, P., (2024), “China’s current monetary policy stance and evolution of monetary policy framework in the future”, Lujiazui Forum. 4. Kazuo, U., (2024), “On the Recent Changes in the Bank of Japan’s Monetary Policy Framework”, Peterson Institute for International Economics. 5. Kent, C., (2024). “The future system for monetary policy implementation”, Bloomberg Australia Briefing. 6. Parliament of Australia (2024), Treasury Laws Amendment (Reserve Bank Reforms) Bill 2023, February 12. 7. Reserve Bank of New Zealand (2023), Monetary Policy Remit amended, December 13. 9911Monetary Policy Report October 2024 and data dependence for future decisions, central by 25 bps in June 2024, marking its first cut in the banks of major systemic AEs embarked on policy current easing cycle. It again announced a cut in its pivots even as some others have paused. Given their deposit facility rate (DFR) by 25 bps in September after pre-emptive tightening at the onset of the inflation keeping it unchanged in July. It reiterated that it would surge, some EME central banks continued with policy continue to remain data-dependant to determine normalisation while few others continued with the the appropriate level and duration of restriction. restrictive stance. Besides, the Asset Purchase Programme (APP) portfolio continues to shrink as principal payments The US Fed initiated a pause in policy tightening in from maturing securities are no longer reinvested. September 2023 and continued to maintain the target The Pandemic Emergency Purchase Programme range for the federal funds rate at 5.25-5.50 per cent (PEPP) portfolio is also set to decline by €7.5 billion in all its subsequent meetings. In September 2024, per month, on average, with reinvestments ceasing however, it lowered the target range for the federal entirely by the end of 2024. The Bank of England funds rate by 50 bps to 4.75-5.00 per cent (Chart V.5a). (BoE) continued with its status quo stance initiated As per the Summary of Economic Projections released in September 2023, followed by first cut of 25 bps in the September meeting, the Federal Open Market in August as inflation risks abated, but paused in its Committee (FOMC) participants expected the target September meeting. The BoE indicated that a gradual range for the federal fund rates to be at 4.25-4.50 per approach in removing policy restraint is warranted, cent by end 2024 and at 3.25-3.50 per cent by end 2025, emphasising that monetary policy will need to remain indicating a further 50 bps rate cut in the remaining restrictive for sufficiently long until the risks for part of 2024 and 100 bps rate cut in 2025. The Fed also inflation to return sustainably to the 2 per cent target continued with its balance sheet normalisation policy. dissipate further. After continuing with the pause that ECB initiated in Amongst other major AEs, the RBA, the Central Bank October 2023, it lowered its three key interest rates of Iceland8, the Bank of Israel, the Norges Bank, and Chart V.5: Policy Rate Changes – Select Major Economies Source: Bloomberg. 8 The Bank of Iceland cut its policy rate by 25 bps on October 02, 2024. 92Chapter V External Environment the Bank of Korea maintained status quo in all their reserve requirement ratio by 50 bps and seven-day meetings during Q2 and Q3 of 2024. After keeping its reverse repo rate by 20 bps to 1.5 per cent. The Bank policy rate unchanged since September 2023, the Bank of Russia (BoR) maintained status quo in Q2:2024 but of Canada reduced it by 25 bps each in all its meetings increased its policy rate by 200 bps and 100 bps in starting June 2024. The RBNZ cut its official cash rate July and September, respectively, of 2024 as inflation by 25 bps in August 2024, following a pause since remained elevated much above the target. July 2023. The Sveriges Riksbank slashed its policy Among Asian EMEs, the Bank of Thailand kept its rate by 25 bps each in May, August and September benchmark rate unchanged in Q2 and Q3 of 2024. 2024 meetings, with a pause in the month of June. The Bank Indonesia cut its key rate by 25 bps in The Swiss National Bank also lowered its policy rate September 2024 following a hike in April while by 25 bps in its June and September meetings. The pausing in intermittent meetings, while the central Czech National Bank reduced its key rate by 50 bps bank of Philippines cut its policy rate by 25 bps in each in both May and June meetings and by 25 bps in August 2024 after maintaining status quo in Q2. In its August and September meetings. In contrast, the Latin America, the central bank of Mexico maintained BoJ raised its key rate by 15 bps in July, following a the policy rate in Q2 but announced two consecutive period of status quo in April and June. Moreover, the rate cuts of 25 bps each in August and September BoJ announced its plan to taper its outright purchase after the first rate cut in March 2024. The central of JGBs at a predictable pace of 400 billion yen each bank of Colombia continued with monetary policy quarter, reaching around 3 trillion yen by January- easing by paring its benchmark rate by 50 bps in each March 2026. The BoJ, however, maintained status quo of its April, June, July and September meetings. Chile in its September meeting. cumulatively lowered its policy rate by 175 bps to In the BRICS economies, the Banco Central do Brasil, 5.50 per cent during April-September 2024 with an continued to maintain its accommodative stance that intermittent pause in July. Peru cut its reference rate started in August 2023 by cutting its Selic rate by 25 by 25 bps each in April, May, August and September bps in May 2024, but paused thereafter in the months meetings but maintained status quo in its June and of June and July. In September, however, it pivoted by July meetings. Among European EMEs, Hungary raising the Selic rate by 25 bps due to emerging upside lowered its policy rate by 50 bps each in its April risks to inflation. The South African Reserve Bank and May meetings and by 25 bps in June, July and cut its repo rate by 25 bps in September 2024 for the September while maintaining a pause in August. first time after keeping it unchanged in May and July Poland maintained a pause in Q2 and Q3 of 2024 meetings. The People’s Bank of China (PBoC) reduced (Chart V.5b). the one-year Loan Prime Rate (LPR) by 10 bps in July V.4 Global Financial Markets after keeping it unchanged in Q2:2024. It reduced the one-year Medium-term Lending Facility (MLF) rate by Global financial markets remained in a state of flux 20 bps in July and 30 bps in September. In September, during Q2 and Q3, responding somewhat unexpectedly it also announced a slew of stimulus measures to to changing perceptions on the monetary policy support the economy, recoup the housing sector and trajectory and data releases.9 Markets turned buoyant restore market confidence including reduction in during May-September 2024 as expectation of rate 9 Bauer, M.D., C.E. Pflueger, and A. Sundaram (2024), “Changing Perceptions and Post-Pandemic Monetary Policy,” unpublished manuscript, FRBKC Jackson Hole conference. 9933Monetary Policy Report October 2024 cuts gained momentum. Notwithstanding the gains, consequent to the BoJ’s rate hike. After undergoing equity markets retreated intermittently since the last a sharp dip in late July and early August, US stock MPR – in April over continued restrictive monetary markets rebounded in August as investors moved policy; in the beginning of August over a confluence back to riskier assets on dovish guidance from the BoJ of factors, including underwhelming data releases for and abatement of recessionary fears. In the first week the US and landmark rate hike by Japan; and in early of September, however, market underwent another September over increased risk-off sentiment amidst correction upon the release of below expectations data releases. Overall, bond yields have moderated PMI data and labour market indicators but soon since the last MPR while the US dollar has pared gains. rallied overhauling the previous loss. Overall, the US Consequently, EME currencies broadly appreciated in S&P index rose by 9.7 per cent during April-September Q3:2024. 2024. European stocks underperformed as bullish Equity markets, in terms of the Morgan Stanley sentiments in other markets attracted investors Capital International (MSCI) world index, gained 8.7 interest. The UK’s stock indices modestly tracked per cent since end-March, reflecting gains in both AEs the US markets in Q2, performing well following and EMEs, with recurrent episodes of volatility (Chart the Labour party’s landslide electoral performance V.6a). Among AEs, the US S&P 500 shed gains in April but relatively underperformed in Q3. The Japanese as strong consumer demand and high PCE inflation market reflected domestic factors exhibiting a sharp rekindled concerns about ‘higher for longer’ interest correction post the BoJ’s rate hike causing yen rates. It, however, rallied starting end-April till mid- appreciation and raising risks on exporters’ earnings’ July amidst easing geopolitical tensions and increased outlook. EME equities gained since end-March, expectations of a rate cut over moderating inflation tracking global cues and lower domestic inflation prints. Thereafter, market sentiment turned sour with prints (Chart V.6b). Chinese stocks, that were losing incoming data sparking recessionary fears in the US ground amidst flagging economic activity and the on top of disorderly unwinding of yen carry trade persistent downturn in real estate, rebounded sharply Chart V.6: Equity Markets Sources: Bloomberg; and RBI staff estimates. 94Chapter V External Environment Chart V.7: 10-Year Sovereign Bond Yields Source: Bloomberg. post the stimulus announcement on September 24, between April and July, pushed up by the BoJ’s policy 2024. rate hike, including tapering of their bond purchase programme, but softened by 20 bps since August on In tandem with Q1:2024, sovereign bond yields across a dovish stance (Chart V.7a). Bond yields in several major AEs continued to harden in April in response to EMEs exhibited a softening bias, driven by easing of expectations of a firmer future path of interest rates, domestic financial conditions as well as global cues sensitivity to rising fiscal risks and tight liquidity (Chart V.7b). Bond yields in Brazil, however, hardened conditions. Beginning May, however, yields softened till July as investors trimmed their portfolios but as incoming data signaled an improving inflation remained volatile thereafter. outlook for the US, raising the odds for an imminent rate cut. Illustratively, the US 10-year treasury yield In the currency markets, the US dollar remained rose by 48 bps in April but shed 78 bps between range bound in Q2:2024, with an upward bias over May-August over evolving perceptions of rate cuts. changing bouts of optimism about policy easing and Subsequently, yields fell precipitously in August and intermittent escalation of geopolitical and electoral early September, remaining below the 4 per cent mark risks increasing safe haven demand. Cooling labour in response to the release of underwhelming high- market conditions, easing inflation and flagging high- frequency indicators. Since mid-September, however, frequency indicators of economic growth, however, yields hardened as market expectations of the led to a policy pivot by the Fed, causing a depreciation Federal Reserve rate cut for November shifted from of the US dollar in Q3:2024 (Chart V.8a). However, in 50 bps to 25 bps. Also, the yield curve inversion i.e. late September the dollar index, changed its course negative 10- minus 2-year spread that had persisted upon the release of better-than-expected labour since July 2022, has reversed to become positive in market data. These movements were mirrored in the September 2024. The UK 10-year bond yield broadly EME currencies, exacerbated by swings in capital flows tracked the US market while the German 10-year yield (Chart V.8b). The MSCI Emerging Market Currency softened in response to the ECB’s rate cut actions and Index remained rangebound in Q2:2024 but rose by forward guidance. Yield on 10-year JGBs rose by 33 bps 4.0 per cent in Q3:2024. 9955Monetary Policy Report October 2024 Chart V.8: Currency Movements and Capital Flows Sources: Bloomberg; and Institute of International Finance (IIF). V.5 Conclusion tread the path of policy normalisation, they remain Global growth remains resilient though flaring cautious on rate cuts and the level of restrictiveness. geopolitical tensions, flagging recovery in China, Greater uncertainty about the evolving policy path and extreme weather events pose downside risks is reflected in financial markets, which are buoyant to the outlook. Inflation remains vulnerable to yet volatile, reacting sharply to policy changes and weak progress in services disinflation, easing economic data releases. Although prospects for EMEs financial conditions, high public debt, strong wage are improving, they remain susceptible to external growth, potential escalation of trade tensions and geopolitical risks and evolving financial conditions geoeconomic fragmentation. Even as most nations in advanced economies. 96