The state of economy: UBS says weather a key factor, expects rate cut in second half of 2024

As domestic economic activity continues to expand supported by the momentum in investment demand and improving global environment, UBS maintains its call for a rate cut towards the later half of 2024.

The fact that RBI kept rates unchanged on April 5 was given and as per estimates. But what really caught everyone’s attention is the RBI stance on inflation. While the Reserve Bank of India has said it will “closely monitor’ the upside risks to inflation, UBS says “climate shocks, oil, growth and Fed” would be key to determining the scope of rate cuts and see inflation moderating to 4% levels in September quarter.
As domestic economic activity continues to expand supported by the momentum in investment demand and improving global environment, UBS maintains its call for a rate cut towards the later half of 2024. On the demand side, they expect household consumption to improve with further pickup in rural activity and steady urban demand.

The big weather worry
The Meteorological Department (IMD) had recently warned about possibilities of heat waves between April- June and global oil prices are currently hovering around US$90/bbl. According to Tanvee Gupta Jain, Economist at UBS India, “We think RBI will remain conscious and closely monitor the evolving upside risks to inflation (including uncertainty on domestic food prices especially vegetables and fruits due to higher than normal temperature).”

She however pointed out that the various global weather models have estimated that La Nina (which typically brings good rainfall) will set in by June and El Nino will turn neutral ahead of the forthcoming monsoon season in India (which runs from June to September). As a result they believe “a likely normal monsoons and a good spatial and temporal distribution of rainfall will bode well for summer crop production, keep food prices in check and support rural demand. In our base case, we continue to expect headline CPI inflation to decelerate below 5%YoY in March and soften further below 4% in September quarter on gradual easing in food prices and comfortable core inflation.”

Maintain call for rate cut in later part of 2024
Given the above premise, UBS maintains the call “for a shallow rate cut cycle in H2 FY25 (cumulative 50bp), following (a) the Fed pivot in June (UBS forecast) even as there are risks emerging of Fed pushing these rate cuts further and (b) as India’s real policy rate also starts inching into restrictive territory (amid faster-than-expected disinflation).”

The report also outlined how liquidity conditions have improved and overnight rate is trading at encouraging levels. “The Rise in tax collections, slowdown in government spending (leading to higher government cash balances with the RBI), and the persistent gap between credit and deposit growth – all contributed to widening in liquidity deficit since Nov 2023. That said, liquidity conditions have improved since March on higher government spending (up 20%YoY in Feb and 7%FYTD),” Jain added while pointing out that the RBI MPC retained CPI inflation projection of 4.5% YoY for FY25 with slight modification to quarterly profile with Q1 at 4.9%YoY, Q2 at 3.8% and Q3 at 4.6% and Q4 at 4.5% and risks evenly balanced.

On the positive side, hopes of a normal monsoon along with prospects of record wheat production would bode well for inflation. While the fuel price disinflation is likely to deepen in the near-term following LPG price cut, the recent upsurge in crude oil prices needs to be monitored. Real GDP growth estimate was kept unchanged at 7% YoY for FY25 MPC retained FY25 real GDP growth at 7% YoY with slight modification to quarterly profile with Q1 at 7.1%YoY, Q2 at 6.9% and Q3 at 7% and Q4 at 7% and risks evenly balanced.
Source: Financial Express