A Shift Towards Neutrality

The Reserve Bank of India (RBI) maintains status quo on policy rates, marking the tenth consecutive pause.

However, a significant change was the shift in monetary policy stance to ‘neutral,’ reflecting a cautious yet evolving approach to inflation management and growth support.

TL: DR

In its October 2024 meeting, the Monetary Policy Committee (MPC) held the policy repo rate steady at 6.50%, keeping the standing deposit facility (SDF) at 6.25% and the marginal standing facility (MSF) at 6.75%.

The outcome aligns with expectations, and we anticipate that the RBI will continue to rely on domestic factors for any rate reversal decision, despite rate cuts occurring in other parts of the world. The shift to a neutral stance was expected and is a positive step toward initiating a rate cut cycle, which could start sooner rather than later.

However, given the challenges related to NBFCs, inflation, and GDP, there may be a slight delay in implementing rate cuts. Nonetheless, we believe such a cycle could begin within the next two monetary policy meetings.

Inflation outlook: cautious but balanced

Inflation projections have been revised, with CPI inflation for Q2 FY25 now expected at 4.1%, for Q3 FY25 at 4.8%, and for Q4 FY25 at 4.2%. The projection for FY25 remains steady at 4.5%, while inflation for Q1 FY26 is projected at 4.3%.

Source: RBI, Fisdom Research

We recognize that while inflation has softened recently (3.6% in July and 3.7% in August), the coming months are likely to witness upward pressure on prices due to base effects and ongoing food inflation challenges. These pressures, largely driven by supply-side issues, underscore the need for cautious optimism. However, strong agricultural prospects, buoyed by good kharif sowing and favorable rabi conditions, provide a potential buffer against more significant inflationary spikes, particularly in the food category.

We believe that inflation risks are not fully behind us yet. While the RBI’s neutral stance allows for greater flexibility in monetary policy, we expect any rate cuts to be contingent upon sustained moderation in inflation, especially as the trajectory for Q3 FY25 moves higher. Additionally, global commodity prices, particularly crude oil, and potential external shocks like geopolitical tensions, could add volatility to the inflation path.

Growth outlook: strong domestic demand with caution on global risks

India’s GDP grew by 6.7% in Q1 FY2024-25, largely driven by strong private consumption and investment. For FY2024-25, the growth projection remains robust at 7.2%, with expected growth in Q2 at 7.0% and Q3 at 7.4%. High-frequency indicators continue to signal steady expansion in the manufacturing and services sectors, which are supporting the overall economic momentum

Source: RBI, Fisdom Research

However, we acknowledge potential challenges from global economic uncertainty and geopolitical tensions. These risks could weigh on export-driven sectors and global trade, possibly creating volatility in the later quarters. While domestic drivers remain solid, businesses and investors should be prepared for potential external shocks that could impact growth in the medium term.

We believe the strength of India’s domestic market will continue to be the primary growth engine. Key sectors like manufacturing and services are expected to maintain their expansion, with agriculture playing a crucial role due to the favorable monsoon.

Liquidity Outlook: surplus with brief tightness amid tax outflows

System liquidity remained in surplus during August to early October 2024, largely due to government spending and a decline in currency circulation. However, there was a brief period of deficit liquidity in late September due to tax-related outflows.

Government spending picked up during the period, boosting liquidity in the system. However, tax payments, including GST outflows, temporarily pressured liquidity. The RBI managed this through proactive two-way operations to maintain alignment with the policy repo rate.

The RBI will continue to use its liquidity management tools flexibly to ensure stability in money market rates. The central bank will aim to keep liquidity conditions balanced, using both injection and absorption measures as needed.

Way ahead

The outcome aligns with expectations, and we anticipate that the RBI will continue to rely on domestic factors for any rate reversal decision, despite rate cuts occurring in other parts of the world. The shift to a neutral stance was expected and is a positive step toward initiating a rate-cut cycle, which could start sooner rather than later.

However, given the challenges related to NBFCs, inflation, and GDP, there may be a slight delay in implementing rate cuts. Nonetheless, we believe such a cycle could begin within the next two monetary policy meetings.

Annexure: does the RBI always align its interest rate decisions with the Fed?

India has historically aligned its monetary policy with the Federal Reserve’s interest rate decisions, although often with a lag or not simultaneously. When the Fed adjusts its interest rates, the ripple effects are felt globally, particularly in emerging markets like India. These changes impact capital flows, exchange rates, and inflation expectations, necessitating a response from central banks around the world.

In India, the Reserve Bank of India (RBI) typically adjusts its policy rates in reaction to the Fed’s moves to manage these effects. While the timing may vary, and the magnitude of the adjustments may differ, the underlying trend is clear: India’s monetary policy is influenced by the Federal Reserve’s actions. This relationship is crucial for maintaining economic stability, as ignoring the Fed’s rate changes could lead to adverse impacts on the rupee, inflation, and overall financial stability.

Source: Fed, RBI, Fisdom Research

For instance, during the 2007-2008 financial crisis, as the Fed aggressively cut rates, the RBI followed suit, albeit with a slight delay, implementing its own rate cuts to support the domestic economy. Similarly, in response to the Fed’s tapering announcement in 2013, the RBI was quick to act, raising the Marginal Standing Facility (MSF) rate to curb currency volatility. More recently, in 2022, when the Fed embarked on an aggressive rate hike cycle to combat inflation, the RBI also raised rates significantly, aligning with the global tightening trend.

So given the historical trends and the latest monetary policy statements, the possibility of an RBI rate cut cannot be entirely dismissed.

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