RBI holds rates, signals rate cuts
After 29 months of tight monetary policy, India's RBI signals potential rate cuts by shifting to a neutral stance, aiming to balance inflation and growth.
After 29 months of a tight-money regime, beginning with a 10-month period when the policy rate increased by 2.5 percentage points to the current 6.5%, making both corporate and retail loans expensive, and extending repayment periods for home loans by years, some relief is finally on the horizon.
If all goes well, the consensus among experts and analysts alike is that the Reserve Bank of India’s Monetary Policy Committee could cut its policy rate at its next meeting in December.
For now, there is the change in stance, a clear indication of intent. On Wednesday, at the end of its October meeting, MPC changed its policy stance from “withdrawal of accommodation” to “neutral”. In plain English that means, the committee believes inflation — growth dynamic is finally under control.
An expected inflationary bump in the December quarter and looming global uncertainties on account of the ongoing conflict in West Asia and the US presidential elections might have played a role in the gradual pivot in monetary policy rather than simultaneous change in policy stance and policy rates. And lower inflation and lower growth projection for 2025-26 over 2024-25 is likely to bring back supporting growth on the MPC’s agenda even as it focuses on controlling inflation.
The MPC meeting of the RBI, with newly nominated external members has decided by consensus to change the stance of monetary policy from withdrawal of accommodation to neutral. The change in policy stance is the first since June 2022 and marks a pivot in the prolonged monetary tightening which happened after a spike in inflation numbers. To be sure, MPC had raised interest rates by 40 basis points in an unscheduled meeting in May 2022 even before completely changing the monetary policy stance. The MPC resolution for this meeting described the policy stance as remaining “accommodative while focusing on withdrawal of accommodation”.
MPC last made an interest rate hike in February 2023, leading to a cumulative hike of 250 basis points between May 2022 and February 2023. The policy rate remains at 6.5% as of now. The increase in policy rates has led to a concomitant increase in retail interest rates too. Data from Centre for Monitoring Indian Economy (CMIE) shows that the weighted average lending rate for fresh rupee loans increased from 7.86% in May 2022 to 9.24% in February 2023. This has inched up further to 9.41% in August 2024, the latest month for which data is available. This is bound to have put a squeeze on finances of households with mortgage payments.
India’s benchmark inflation rate, which is measured by the Consumer Price Index (CPI) was above 6% -- the upper band of RBI’s target range of 2%-6% -- for five consecutive quarters between March 2022 to March 2023. This was the first time the central bank failed to meet its inflation targeting mandate – defined as inflation staying above the target band for three consecutive quarters – and it had to send a written report to the finance ministry as per the terms of the inflation targeting law. The contents of RBI’s response to the government have not been made public till date.
While quarterly inflation has remained within the target band for four out of the five quarters after March 2023, the MPC and Governor Shaktikanta Das have remained hawkish insisting that MPC’s desired objective is in alignment with the 4% inflation target rather than the range.
To be sure, MPC’s and governor’s tone and analogies on the inflation situation have changed during this period. “The (inflation) elephant has now gone out for a walk and appears to be returning to the forest. We would like the elephant to return to the forest and remain there on a durable basis”, Governor Das said in his statement in April 2024. “It is with a lot of effort that the inflation horse has been brought to the stable, i.e., closer to the target within the tolerance band compared to its heightened levels two years ago. We have to be very careful about opening the gate as the horse may simply bolt again. We must keep the horse under tight leash, so that we do not lose control”, Das said in his latest statement suggesting that the central bank is more willing to take credit for controlling inflation now than six months ago.
As to the larger view within the MPC, the change in external members has reduced dissent but not eliminated it on the rate cut question. External member Nagesh Kumar voted against the other five members, asking that the policy rate be reduced by 25 basis points. Two external members in the previous MPC had asked for a rate cut and change in policy stance.
Is there any other tangible change in the MPC’s assessment apart from the change in policy stance? As far as headline growth and inflation projections are concerned, the remain unchanged at 7.2% and 4.5% respectively between the August and October meetings. To be sure, the quarterly projections for growth and inflation have seen a slight change. Projected GDP growth for quarters ending September 2024, December 2024 and March 2025 have been revised to 7%, 7.4% and 7.4% in the October resolution compared to 7.2%, 7.3% and 7.2% in the August resolution. As for inflation, the numbers have changed to 4.1%, 4.8% and 4.2% respectively in the October resolution from 4.4%, 4.7%, and 4.3% in August. This also means that had the MPC cut rates in its October meeting a spike in inflation in the December quarter would have been bad optics.
To be sure, the MPC has justified its staggered pivot – first a policy stance change and then (as expected) rate cut – on the lines that it “provides flexibility to the MPC while enabling it to monitor the progress on disinflation which is still incomplete” even as “risks stem from uncertainties relating to heightened global geo-political risks, financial market volatility, adverse weather events and the recent uptick in global food and metal prices”.
MPC’s approach has been supported by independent economists. “We believe RBI aptly put the horse before the cart”, HSBC Chief India economist Pranjul Bhandari said in a research note. “ RBI seems to be sequencing its moves carefully, starting off with a softening of stance today. We believe the next move will be a 25bp rate cut in the December meeting”, Bhandari added. “We believe the recent softness in select fast moving growth indicators (PMI Manufacturing, motor sales, cement production, bank credit, corporate tax collections, GST revenue growth and goods exports) is more representative of sector rotation (from urban to rural) rather than a marked slowdown. Therefore, we think this will be a shallow rate cutting cycle, with an aggregate 50bp in easing. We expect a 25bp rate cut in December, followed by another one in February, taking the policy rate to 6%”, the note added.
While MPC’s projections are only available till the first quarter of the next fiscal year the Monetary Policy Report (MPR) released by the RBI says that it expects inflation and growth to be 4.1% and 7.1% in 2025-26. This means that the RBI would be more comfortable cutting interest rates going forward. Governor Das’s statement after the meeting does give a sense of imminent policy triumph this time. “We stand unambiguously committed to ensure durable alignment of inflation with the target, while supporting growth. In the prevailing macroeconomic conditions and the outlook, Mahatma Gandhi’s words remain highly relevant: “When the method is good, ... Success is bound to come in the end”, it said.