RBI holds repo rate, adopts neutral stance, opens door for rate cut

If we see higher inflation in September-October and 7% GDP growth in September quarter, will the RBI go for a rate cut in December? Or, will that be pushed to February?

Once again, the Indian central bank has maintained status quo at the October meeting of its rate-setting body when it comes to the policy but opened the door for a rate cut in future.

The newly constituted Monetary Policy Committee (MPC) has kept the repo rate, or the rate at which the central bank lends money to commercial banks, unchanged at 6.5 per cent but it has changed the stance from “withdrawal of accommodation” to “neutral”. Five out of six members of the MPC have voted for the status quo on rate; the decision on change in stance is unanimous.

One can argue that the change in stance is a formality as the Reserve Bank of India (RBI) has all along taken care that there is adequate liquidity in the system. For instance, the liquidity in the system was in surplus in August-September and early October, and when it had turned into deficit for a brief period in the second half of September, the RBI infused money into the system. But the change in stance signals the change in the direction of the central bank’s approach to the policy.

After the change in stance, the RBI has committed to continue to be nimble and flexible in its liquidity management operations. “We will deploy an appropriate mix of instruments to modulate both frictional and durable liquidity so as to ensure that money market interest rates evolve in an orderly manner,” the governor’s statement says.

The government bond market welcomed the policy with a mini rally. The 10-year bond yield dropped to 6.73 per cent before surrendering some of its gains and closing at 6.7675 per cent. 

When will we see the rate cut? Many analysts are pencilling in a 50-basis point (bp) rate cut by February 2025 — a 25-bp rate cut each at the next two MPC meetings in December and February. One bp is a hundredth of a percentage point.

Is that for sure? Before the next MPC meeting in December, the RBI will have the September and October inflation data and the growth figure of the second quarter of 2024-25 (FY25). The retail inflation softened significantly in July and August (3.6 per cent and 3.65 per cent, respectively, below the RBI’s flexible inflation target of 4 per cent, with a 2-percentage-point band on either side) with base effect playing a major role in July. It is  expected to see a “big jump” in September due to unfavourable base effects and pick-up in food price momentum, and is likely to remain elevated in the near-term due to adverse base effects.

As far as real gross domestic product (GDP) growth is concerned, the RBI’s estimate for the second quarter is 7 per cent which rises to 7.4 per cent in the last two quarters.

If indeed we see higher inflation in September and October and 7 per cent growth in the second quarter, will the RBI still go for a rate cut in December? Or, will that be pushed to February? When did we last see a 7 per cent growth rate serving as the backdrop of a rate cut? There had not been too many such occasions. Of course, while there are upside risks for inflation, the Monetary Policy Report, released along with the policy statement, talks about 4.1 per cent inflation in FY26. The future inflation expectations can  encourage the RBI to cut the rate in December.

Going by the governor’s statement, at the moment, the macroeconomic parameters of inflation and growth are well balanced. The headline inflation is on a downward trajectory, though its pace has been slow and uneven and the resilient growth gives the RBI the space to focus on bottling inflation at the 4-per cent target.  

The change in stance is backed by the MPC’s assessment that at the current juncture, it’s “appropriate to have greater flexibility and optionality to act in sync with the evolving conditions and the outlook”.

The RBI has kept the FY25 retail inflation projection unchanged at 4.5 per cent and real GDP growth estimate at 7.2 per cent. At the moment, the growth projection seems to be on the higher side but RBI surely has more information on its table than what we see.

The MPR puts the FY26 growth forecast at 7.1 per cent.

As the policy states, growing divergence in inflation-growth dynamics across countries has led to different policy responses. Hours before the RBI announcement, New Zealand's central bank cut rates by 50 bps to 4.75 per cent, the second rate cut since August which had kicked off the easing cycle with a 25-bp cut.

In September, the US Federal Reserve announced its first rate cut since the early days of the Covid pandemic and more will follow. Eurozone inflation dipped below 2 per cent in September for the first time since mid-2021, raising the possibility of yet another rate cut by the European Central Bank. Analysts expect the Bank of England to announce a rate cut in November. It’s a question of months before the RBI takes the call.

Going beyond the rate and stance, this policy has sent a few strong messages to the “outliers” among the non-banking financial companies which have been “aggressively pursuing growth without building up sustainable business practices and risk-management frameworks”. The governor’s statement also refers to the “push effect” — business targets and not demand driving the retail credit growth.

The RBI is fully aware that the high-cost loans and high indebtedness of the borrowers could pose financial stability risks, if not addressed by these NBFCs. Governor Shaktikanta Das has issued a stern warning, saying the RBI is closely monitoring these areas and will not hesitate to take appropriate action, if necessary, if the culprits don’t opt for self-correction.

Watch out for some actions, soon. The RBI would not love to see an encore of 2018 in the NBFC space.

The writer is an author and senior advisor to Jana Small Finance Bank Ltd.

His latest book: Roller Coaster: An Affair with Banking. 

To read his previous columns, please log on to www.bankerstrust.in

X: @TamalBandyo