Inflationary pressures and the exercise of rate cut measures

Between 1 January 2023 and 15 December 2023, the deposit portfolio of the banking sector increased by 14 percent to Rs. 197.92 lakh crore, while loans increased by 20.2 percent to Rs. 158.05 lakh crores. India's foreign exchange reserves rose to $620.44 billion on December 22 from $562.85 billion at the beginning of the year. The rupee also ended the year at 83.21 against the dollar, down from 82.66 at the start of the year, before hitting a low of 83.50 on November 10. Retail inflation, which was 6.52 percent in January, declined to 5.33 percent in November. In this 11-month period, inflation was seen at a low of 4.31 percent in May and a high of 7.44 percent in July.

India is no longer influenced by global events and doesn't even care what the Federal Reserve in the US is doing. But the fact is that a lot depends on what the Reserve Bank does in 2024. Coincidentally this year elections are to be held first in India and then in America.

The fight against inflation is not over yet. No one knows this better than RBI Governor Shaktikanta Das. By mid-2023, India's central bank looks set to quietly raise its inflation target from 4 percent to 6 percent, which is the upper end of its range (the target is 4 percent, plus or minus 2 percent). They will be in no rush to reduce policy rates. Retail inflation is estimated at 5.4 percent for this financial year till March. It is 5.02 percent for March and June quarter of 2025. After that, it is expected to decline to four percent in the September quarter and rise to 4.7 percent in December.

Finally, in September 2019, retail inflation was 3.99 percent. In fact, retail inflation was less than 4 percent in the 11 months between August 2018 and September 2019. After that it remained close to 4 percent and once in January 2021 it was 4.06 percent. In other words, retail inflation has been consistently above target in the last 4 years. It not only reduces the value of common people's wealth but also reduces their consumption capacity. If inflation is not controlled, growth will suffer.

The RBI wants to tackle the specter of inflation at four per cent before making a sustained cut in rates. So, we have to wait for the rate cut. The cuts should happen this year but will depend on the pace of growth and inflation and the actions of the Fed in the US.

If indeed the Fed cuts rates three times, the big question is how much the RBI will cut this year. It will depend on inflation trends and real interest rates. The last rate was 25 basis points in February 2023, the lowest since rate hikes began in May 2022. In these 10 months, the policy rate has increased from 4 percent to 6.5 percent. Earlier in February 2019, the policy rate had touched the level of 6.5 percent. Then retail inflation was 2.57 percent.

Banks will continue to struggle to collect deposits as savers look for other avenues of investment. Deposit rates will remain high until inflation is brought under control. This will affect the interest income of banks as current and savings account balances will continue to decline due to lower costs. It will also affect the lending capacity of some banks. These banks are currently supporting higher credit growth with their capital because their deposit portfolios have not grown as fast as loan growth. There may come a time when they have no choice but to slow down the pace of lending.

The quality of asset accounts across the banking industry is currently the best it has been in the last decade. Even so, some defaults are happening in the unsecured personal loan sector, though not so dramatically yet. Some non-banking financial companies that are in the short-term unsecured consumer credit sector may run into trouble. The Reserve Bank is monitoring them. Cases of digital fraud and phishing are constantly increasing. Fixed deposits have also been hacked. Finally, the Reserve Bank's focus on banking operations will continue. Along with this, customer care may also come into focus this year.