“We believe slowing inflation despite food price hiccups, a smaller fiscal deficit and an imminent turn in the US Federal Reserve policy rates will create the ground for the MPC to start cutting rates. But the RBI is wary of doing so too early, or even changing its stance as inflation is not yet firmly…
After the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) announced to keep the repo rate steady for the sixth straight time at its review meeting on February 8, 2024, economists at CRISIL said the central bank could push the decision to cut rates at least to June 2024, if not later. “We believe slowing inflation despite food price hiccups, a smaller fiscal deficit and an imminent turn in the US Federal Reserve policy rates will create the ground for the MPC to start cutting rates. But the RBI is wary of doing so too early, or even changing its stance as inflation is not yet firmly under control,” said Dharmakirti Joshi, Chief Economist; Dipti Deshpande, Principal Economist; and Sharvari Rajadhyaksha, Economic Analyst, at CRISIL.
“We believe more clarity on the path of disinflation – shaped by food prices and the trend in crude oil prices given the tensions around the Red Sea — could push this decision at least to June 2024, if not later. While consumer price inflation (CPI) has remained in the RBI’s tolerance band of 2-6 per cent since August, it still is away from its 4 per cent target and that keeps the MPC on watch,” CRISIL economists’ analysis stated.
The RBI MPC also continued its stance of ‘withdrawal of accomodation’. With this decision of ‘no change’, the entire fiscal 2024 now has seen no movement on the policy rate and no alteration in the stance. Yet, CRISIL said, interest rates in the market have risen. The interbank call money rate is 25 basis points (bps) higher than its March 2023 level, and so is the one-year marginal lending facility rate (MCLR).
“The MPC is steadfastly pursuing two goals; (i) complete transmission of its 250 basis points (bps) rate hike in this cycle; and (ii) aligning headline inflation to its target of 4 per cent on a durable basis,” the report said.
February monetary policy review
The MPC, on February 8, voted with a 5-1 majority to keep policy rates unchanged. The repo rate remains at 6.50 per cent, standing deposit facility (SDF) at 6.25 per cent and marginal standing facility (MSF) at 6.75 per cent. The monetary policy stance of ‘withdrawal of accommodation’ was also maintained with a 5-1 majority. The CPI forecast stands at 4.5 per cent for fiscal 2025, down from an estimated 5.4 per cent in the current fiscal. The MPC forecasts stated that inflation will peak at 5 per cent in the first quarter of fiscal 2025 and then moderate to reach 4.7 per cent in the fourth quarter. India’s GDP growth is forecast to slow a tad to 7 per cent for fiscal 2025 from 7.3 per cent this fiscal, with quarterly estimates revised up from the previous forecast.
Factors influencing the MPC’s decision
Growth exceeded expectations: GDP growth in fiscal 2024 came in higher-than-expected at 7.3 per cent, and also further up from 7.2 per cent in fiscal 2023. The RBI expects GDP growth to remain strong at 7 per cent in fiscal 2025. While the MPC believes resilient manufacturing and services sectors, improving domestic consumption and capex (both private and government) will be supportive of growth, CRISIL, however, expects GDP growth of 6.4 per cent in fiscal 2025 due to the impact of somewhat slower growth in key trade partners and high domestic interest rates that should moderate demand.
Food inflation: Between April and December 2023, although overall inflation softened by ~130 bps on-year, on average, food inflation rose 15 bps and offset the 230 bps drop in non-food inflation. Going into fiscal 2025, the MPC expects CPI inflation to soften to 4.5 per cent average, with risks evenly balanced. CRISIL’s inflation forecast is also at 4.5 per cent average for fiscal 2025. “Stubborn food prices, particularly, of some key food items such as cereals and pulses remain a concern. Also, a mild upside to core inflation needs monitoring as commodity prices are unlikely to come down at the same pace as they did this fiscal. This, coupled with a low-base effect, could mean a slight uptick in non-food inflation. Crude oil prices will also be monitorable given the disturbances along the critical Red Sea trade route,” it said.
Transmission to lending and deposit rates is work in progress: The RBI has raised the repo rate by 250 bps since May 2022. However, this has not been completely transmitted to lending and deposit rates. The RBI is using liquidity tools to speed up this process. To be sure, the deposit rate, which was steady for the last 3 months, rose 5 bps in January and vehicle loan rates increased 2 bps. On the other hand, money market rates have risen at a faster pace than the repo rate due to tighter systemic liquidity, which has driven up rates over the past few months.
Fiscal prudence to support monetary policy: The Interim Budget has lowered the fiscal deficit target to 5.1 per cent for fiscal 2025 from a revised 5.8 per cent in fiscal 2024 and remains committed to bringing down the fiscal deficit to ~4.5 per cent of GDP by fiscal 2026. A lower fiscal deficit would create headroom for the RBI to start easing policy rates this year.
Effect of policy action from other central banks: Several key central banks including the US Fed, the European Central Bank (ECB) and Bank of England have held interest rates steady at their latest meetings. In fact, the Fed has also hinted at a faster easing path with its dot plot projecting the key interest rate at 4.6 per cent by 2024-end compared with 5.1 per cent previously projected. This implies the Fed will cut rates by a cumulative 75 bps in 2024.