RBI monetary policy review: Hawks rule over doves

The repo rate and the stance were not expected to be changed in this policy, and they were not. However, there were some hopes among market participants that the tone of the policy might be a bit dovish, given that there are now strong expectations for the US Federal Reserve (Fed) to be aggressive in its rate-cutting cycle.

The Reserve Bank of India (RBI) has not only stayed away from exhibiting any intention to follow the Fed but has also shown maturity by not providing any forward guidance on rates, given considerable uncertainty in global financial markets, risks to domestic inflation, and considerations of domestic financial stability.

The RBI, in fact, appeared a tad more hawkish than in the previous monetary policy committee, probably to firmly establish the fact that markets need not jump the gun and expect the RBI to follow the Fed. In this context, the RBI indicated that there is still a distance to cover to align inflation with the 4 per cent target. The inflation projections support this argument.

First, the average inflation expected for the second quarter of 2024-25 (FY25) has been increased by as much as 60 basis points (bps) to 4.4 per cent from 3.8 per cent previously. The first look at the first quarter 2025-26 at 4.4 per cent also does not seem promising enough for the RBI to signal a victory on inflation.

The governor’s commentary also addresses the recent debate about whether it would be more suitable for the RBI to target core rather than headline inflation, given that monetary policy would have little control over supply-side inflation.

It is rightly highlighted that food continues to form around 46 per cent of headline inflation in the country, and high food inflation can lead to an increase in household inflation expectations, which, in turn, can be detrimental to the future inflation trajectory.

In July, the one-year-ahead inflation expectations are higher by 30 bps from the levels in March 2024, and that may not be comforting for the RBI.

Apart from the fact that inflation continues to miss targets, there could be another reason why the RBI might not be able to soon signal easier monetary policy. This comes from the stress that the RBI places on proactively flagging risks and challenges to the banking sector.

For the RBI, a high credit-deposit (C-D) ratio of the banking system had been of some concern, and it could be true that the RBI would want to see the C-D ratio come down to more reasonable levels before easing monetary policy.

Banks had been facing challenges in retail deposit mobilisation, leading to banks taking recourse to short-term non-retail deposits to meet credit needs. This could lead to large asset liability management mismatches, resulting in liquidity risks for the banks. The recently proposed tighter liquidity coverage ratio regime should be seen as an effort to cap this risk.

Thus, credit growth needs to be moderated, and the RBI has been taking steps to reduce banks’ exposure to unsecured lending.

Any signal towards an easier monetary policy could increase the challenges for banks to raise retail deposits. Therefore, an easier monetary policy will run contrary to the RBI’s efforts to reduce banks’ C-D ratios.

Thus, the view is that there is a rising risk of no repo cut in FY25, and the cautious approach of the RBI could continue until inflation risks cool and the C-D ratio moderates.

The writer is a chief economist at YES Bank. Views expressed are personal