'Russian roulette' in markets, RBI flags volatility risks

MUMBAI: RBI has warned of a 'Russian roulette' scenario as market expectations regarding central banks are reset. The regulator noted significant volatility risks, given that markets experience wild swings with each new data release, in its State of the Economy report.

The US jobs data in Aug had caused a market downturn, only for it to rebound later. Subsequently, a manufacturing report in Sept triggered another selloff in US stocks, which then spread to Asian and European markets. In India, while IPO activity remains strong, there are concerns about promoters selling off holdings at high prices, especially in the SME segment.

"As markets recalibrate their expectations of central banks pivoting from divergence to convergence, a Russian roulette seems to be playing out. Every incoming data dispels the gathering good feeling of a soft landing and sparks fears of a thudding end to disinflationary monetary policy pathways," the report, authored by RBI staff and led by deputy governor Michael Patra, said. Despite these fluctuations, the report observes that markets have shown resilience, recovering quickly without significant exchange rate movements or liquidity issues. Interestingly, on the day the report was released, markets rose again following a US Federal Reserve rate cut.

The report notes that investors will focus on a select group of emerging economies that benefit from favourable global trade trends, a strong US dollar, economic reforms, and political changes. Additionally, RBI staff has taken a firmer stance on food inflation, pointing out that while headline inflation has moderated, food price volatility remains a risk. The report anticipates higher inflation numbers this month due to an unfavourable base effect. "The pace of disinflation is frequently interrupted by volatile and elevated food inflation. It is the headline inflation that matters, with food inflation accounting for 46% of the overall figure," it emphasises.

While chief economic adviser V Anantha Nageswaran has suggested excluding food prices from inflation targets, RBI maintains that they are crucial to understanding Indian prices. The report projects GDP growth for FY24 at 7.3% - up from the 7.2% forecast in Aug. "The in-house dynamic stochastic general equilibrium model projects GDP growth at 7.3% (YoY) and headline CPI inflation at 4.6% (YoY) during 2024-25," it states.

Other macro data indicates that household consumption is expected to grow faster in Q2 as inflation eases, supported by a revival in rural demand. The widening trade deficit and an increase in overseas travel by Indians are likely to shift the current account balance from a small surplus in early 2024 to a deficit of 1-1.2% of GDP in the first half of 2024-25.