RBI monetary policy review: Wait for rate cut, change in stance gets longer

Less than 24 hours before the Reserve Bank of India’s second monetary policy in FY25, the European Central Bank cut the interest rates for the first time in nearly five years. It lowered its benchmark deposit rate by a quarter percentage point to 3.75 per cent as it felt it’s “now appropriate to moderate the degree of monetary policy restriction” after a 2.5 percentage points fall in inflation since its last rate rise in September 2023.
 

Just ahead of that, the Bank of Canada cut its target for overnight rate by an equal quantum to 4.75 per cent from 5 per cent – the first G-7 central bank to do so.

As expected, these do not have any impact on the RBI’s second monetary policy of FY25.  Even Federal Reserve action will not influence the Indian central bank’s call on policy rate, RBI governor Shaktikanta Das said on Friday, emphatically refuting the view that the central bank is guided by the principle of ‘follow the Fed’ when it comes to monetary policy.
 

“I would like to unambiguously state that while we do keep a watch on whether clouds are building up or clearing out in the distant horizon, we play the game according to the local weather and pitch conditions. …Our actions are primarily determined by domestic growth-inflation conditions and the outlook,” he said.
 

Yet again, the RBI opted for the status quo – both on the rate as well as the stance of the policy. The decisions, taken three days after a smaller-than-expected poll victory for the Bharatiya Janata Party, ushering in a coalition government, don’t have any surprise. The policy rate remains unchanged at 6.5 per cent, for the eighth straight meeting, and the stance, withdrawal of accommodation.
 

But there is a difference between the June policy and that of April. Five of the six members of the Indian central bank’s rate-setting body, monetary policy committee, had voted for the status quo on both the policy rate and the stance in April. This time, two of them have rooted for a cut in policy rate and change in stance. Ashima Goyal has joined Jayanth R. Varma.
 

There has been no change in the RBI’s projection of inflation in FY25 from its past estimate – it remains the same at 4.5 per cent. But the real GDP growth projection for the current financial year has been raised from 7 per cent to 7.2 per cent. If the RBI’s projection comes right, the Indian economy would grow at least 7 per cent or more for four consecutive years. The risks for both growth and inflation projections are “evenly balanced”.
 

When will we see a rate cut? Not too soon. For the time being, the RBI will watch out for the monsoon and the Union Budget for FY25. The exceptionally hot summer season and low reservoir levels are likely to put stress on the summer crop of vegetables and fruits even as an above-normal monsoon may iron out the glitches. The central bank will also keenly watch the coalition government’s fiscal policy and spending pattern.
 

In its current setting, the monetary policy, Das has said, remains squarely focused on price stability to effectively anchor inflation expectations and provide the required foundation for sustained growth over a period of time. The growth-inflation dynamics are evolving favourably but the last round of inflation remains sticky. It expects to drop to 3.8 per cent in the second quarter of the current year but will bounce back to at least 4.5 per cent in quarter three and four. The RBI follows a flexible inflation target of 4 per cent with a 2 per cent band on either side.
 

The combination of strong growth and above-target inflation does not make a case for a rate cut and even a shift in the policy stance too soon. The voting pattern at the MPC has changed but the two dissenters will have their last policy in August and, for the October policy, we will have a new MPC.
 

Those who believe that the US Fed will go for a rate cut in September and RBI will follow soon will also have to fine tune their expectations after Das made it clear that he would not follow the Fed.
 

The market seems to be happy with the policy and the bond yield remained almost flat. More than the policy, which has been on a predictable path for quite some time now, the bond market is eagerly waiting for India’s inclusion in the JPMorgan Government Bond Index-Emerging Markets global index suite which will start later this month. India will also be included in the Bloomberg Index Services’ emerging market indices from January 2025. Higher foreign funds flow will take care of surprises on the demand side, if any, in the Budget.

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