RBI may keep interest rates on hold as slim Modi win boosts fiscal risks

By Anup Roy and Malavika Kaur Makol

India’s central bank will likely keep interest rates on hold well into this year as a weak election win for Prime Minister Narendra Modi’s ruling party fans fears of fiscal populism.
 

The Reserve Bank of India will probably leave the benchmark rate at 6.5 per cent for an eighth straight meeting on Friday, according to all 34 economists polled by Bloomberg. The six-member monetary policy committee is also expected to retain its stance.

The decision comes just days after Modi’s Bharatiya Janata Party lost its majority in parliament and is forced to share power in a coalition government. Economists say there’s a risk a BJP-led government may veer from its fiscal path by raising welfare spending to shore up support, an approach that may stoke inflation that’s already above the RBI’s target. 

The central bank will “have to watch the fiscal outcome of the next month’s budget now more closely before considering the monetary policy path,” said Citigroup Inc. economists Samiran Chakraborty and Baqar Murtaza Zaidi. “A status quo in the June policy is an even more likely outcome with the focus on reducing volatility in uncertain times.”

Economists had already been pushing their forecasts for rate cuts to later in the year, predicting the RBI won’t move until the US Federal Reserve pivots. 

With a hold almost certain, traders will be turning their focus to Governor Shaktikanta Das’ views on the new government and its fiscal policy in the upcoming budget. The RBI’s record Rs 2.1 trillion ($25 billion) dividend to the government, though, gives it some buffer to boost spending.

Traders will also be watching out for RBI’s comments on system liquidity ahead of India’s inclusion in JPMorgan Chase & Co.’s bond index later this month. 

Here’s what’s expected from Das when he announces the rate decision at 10 a.m. in Mumbai: 

Growth and Inflation 

The central bank will likely maintain its projections of 7 per cent gross domestic product growth and 4.5 per cent average inflation in the financial year through March 2025. 

Das has said the rate-setters won’t pivot until inflation settles around the RBI’s 4 per cent target on a sustainable basis. Inflation was at 4.83 per cent in April. With growth topping 8 per cent in the last fiscal year, RBI has enough room and reasons to keep rates higher for longer.  

Goldman Sachs Group Inc. has pushed its rate cut call to the end of the year, while Morgan Stanley and MUFG Bank don’t see a move until 2025, giving RBI time to monitor possible policy shifts, while keeping a close watch on the monsoon and the Fed’s rate path.

“The RBI’s policy calculus will not change,” said Dhiraj Nim, an economist at ANZ Banking Group Ltd. “The central bank will remain focused on bringing inflation down, remaining hawkish for longer and taking comfort from strong growth.”

Policy Stance

The RBI has maintained its hawkish stance of “withdrawal of accommodation” since June 2022. Most economists don’t expect a change to the relatively hawkish stance just yet, as it might signal the central bank is preparing to pivot. 

“Given the uncertainty on food inflation and Fed policy outlook, RBI is unlikely to be in a hurry to cut interest rates. To signal this the status quo on stance is expected,” said Gaura Sen Gupta, an economist with IDFC First Bank. 

Bonds and Liquidity

India’s bond index inclusion brings the central bank’s liquidity management in focus. While RBI is trying to keep cash conditions tight to aid rate transmission, billions of dollars of flows into its bonds will add to the challenge. 

They may continue conducting reverse repo auctions to drain any excess liquidity from the system and may consider doing sell-buy swaps, said Abhisek Bahinipati, head of prop trading at Mirae Asset Capital Markets India.