RBI monetary policy: 'Prioritise liquidity support over rate action'

Despite high geopolitical tension and uncertainties in the global economy, India witnessed strong growth prints, moderating inflation, modest fiscal and current account deficits, decent interest from fore­ign institutional investors (FIIs), and a stable currency, till about a couple of months ago. But, the scenario has changed rather rapidly since then. 

With the shockingly low Q2 GDP growth of 5.4 per cent year-on-year (Y-o-Y) last week, growth during the first half of 2024-25 stands at 6 per cent. Thus, India’s overall GDP growth in 2024-25 looks set to reach low- to mid-6 per cent only, missing the RBI’s projection of 7.2 per cent by miles. Private consumption, typically the mainstay of India’s growth, decelerated in Q2 negating a hugely favourable base (Q2FY24: 2.6 per cent), in line with the softening urban consumer confidence revealed by the latest RBI survey. The momentum in government capex is slower than last year as expected, while uptick in private capex is at best modest.  

Contribution from net exports improved in the current reading, without which Q2 GDP growth could have been worse. Credit growth to industry has decelerated from 10.2 per cent in July 2024 to 8 per cent by October. 

Headline CPI crossed 6.2 per cent Y-o-Y in October, driven largely by perishables and volatile items. Core inflation had been considerably lower. While there had been debates whether the softening core inflation should be given precedence over headline inflation, the RBI had been categorical not to dilute focus on headline CPI.   

Finally, in the past two months, India witnessed about $14 billion FII outflows, largely from the equity market, amid strengthening dollar index, selloff in various emerging economies, and, closer to home, surge in relative attractiveness in Chinese equities triggered by stimulus measures. This has resulted into about 1 per cent weakening in the USD-INR pair and nearly $50 billion drop (inclu­ding revaluation effects) in India’s forex reserves since end-September.   

In the recent past, the RBI repeatedly expressed their confidence in the underlying growth trends and committed to “steadfastly focus on the last mile of disinflation” even when their projection of average CPI inflation of 4.5 per cent for FY25 appeared achievable. Thus, the recent set of macro data will possibly bring in considerable pressure on the RBI. In this week’s meeting, one would expect the RBI to reduce their FY25 GDP growth forecast to around 6.5 per cent and raise the CPI forecast by 20-30 basis points over the existing 4.5 per cent.  

Taking into account the RBI’s repeated emphasis to err on the side of caution on the inflation front and the recent CPI and INR movements, a repo rate cut in December is ruled out. However, the MPC will likely offer a more nimble guidance, much in line with their October communication, and emphasise heavily on the data-dependent nature of future policy actions without ruling out any possibility in the coming months. 

Finally, one expects the RBI to turn more nimble in managing liquidity. Growth in reserve money — the measure of primary liquidity infusion by the central bank into the banking system – fell sharply to a compounded annual growth rate (CAGR) of merely around 7 per cent since mid-2022, in sharp contrast to a long-term growth rate of 12-15 per cent. A stronger growth in reserve money should boost durable liquidity for the banking system, and in turn support the much needed healthy credit growth for the productive sectors of the economy.  

The author is chief economist & head of research in Bandhan Bank. The author thanks Sudarshan Bhattacharjee and Gaurav Mukherjee for assistance. 

Views are personal.