RBI policy: Prelude to future rate cuts? Inflation numbers hold the key

The major takeaway from the credit policy is the change in stance, as it was unexpected. The fact that this was unanimous points to a common view taken by all the six members. This is important because it is largely assumed that a change in stance to ‘neutral’ is a prelude to a rate cut possibility in the future policies. This follows from the view that changing both the repo rate and the stance at the same time is not appropriate, as the power of the stance gets diluted when they are done in unison.  

The change in stance is based on the premise that the growth-inflation matrix is well balanced and conditions are favourable for attaining the goal of durable low inflation in the near future. This raises the issue of whether a repo rate cut is possible in December, as the stance has been changed in this policy.

Going by the forecasts made by the Reserve Bank of India (RBI) on inflation for the balance quarters, there will be an uptick to 4.8 per cent in the third quarter (Q3), which will be the October-December period. It is subsequently supposed to come down in Q4 to 4.2 per cent, which is a signal for assuming durable low inflation. Therefore, a cut in repo rate in the December policy looks unlikely and will have to be pushed forward to February 2025, unless the inflation numbers surprise significantly on the downside in the next couple of months. 

Inflation risks

The policy remains open-ended on the future possibility of rate cut, which sounds reasonable given that the future course of inflation is hard to gauge. The policy highlights three possible risks for inflation. The first is weather changes that can affect food inflation. The monsoon has not yet withdrawn fully, and any possibility of heavy rains can affect harvests. 

Second, the geo political situation is tenuous with the threat of oil prices going up again. While this has not happened when the Israel conflict started, the entry of Iran can change this direction. Third, other commodity prices such as those of metals have been going up, which can add to core inflation. Here the China factor will have a role to play. 

The policy has presented a balanced view of risks and signaled that while it does feel that conditions would be improving on the inflation front, one cannot be too sure. Therefore, the change in stance to neutral echoes that sentiment. There has been no change in the GDP growth forecast, which means that there is no concern on this variable. This has been supported by strong growth in both consumption and investment, which is expected to continue. 

It is hence indicative of the fact that the present interest rate regime does not militate against growth.  With inflation moving down and a good kharif harvest, chances of rural and urban consumption improving looks likely.  

 

The market reaction would need to be seen. While bank deposit and lending rates would be driven more by liquidity conditions of individual banks, bond yields should move down further. So far they have been influenced more by decisions taken by other central banks as well as liquidity situations. A further downward movement can be expected that will help the government in particular as borrowing costs come down. 

The change in stance is the first alteration made by the MPC ever since the Ukraine war when rates and stance were changed. This does indicate a return to equilibrium state for the economy in the coming months.

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Madan Sabnavis is the chief economist at Bank of Baroda and author of: Corporate Quirks: The darker side of the sun. Views are personal.