 |
|
The Reserve Bank of India (RBI) has taken a significant step by transitioning its monetary policy stance from 'withdrawal of accommodation' to 'neutral.' This shift, unanimously approved by the Monetary Policy Committee (MPC) except for one dissenting member who favored a rate cut, reflects a change in focus towards balancing economic growth and inflation. The neutral stance empowers the RBI with greater flexibility to manage liquidity, facilitating the transmission of policy rates into broader interest rates.
The decision to adopt a neutral stance is influenced by both global and domestic factors. Internationally, central banks in developed and emerging markets are easing policy rates and injecting liquidity in response to evolving growth and inflation dynamics. Despite some exceptions like Japan, Brazil, and Russia, the trend towards looser monetary policy is evident. While commodity prices have recently risen following stimulus announcements by China, the slowdown in global growth is reflected in declining oil prices due to weak demand. Even amidst heightened geopolitical tensions, oil prices have not sustained above $80 per barrel.
Domestically, although some economic indicators have shown weakness, suggesting growth concerns, the RBI has maintained its growth estimate for Fiscal Year 2025 (FY25). The lower-than-expected Q1 growth was attributed to reduced government spending, while Q2 growth is expected to be impacted by above-average monsoon rainfall, leading to lower power demand. While the RBI has revised its H1 growth projection downwards to 6.9% from 7.1%, it has raised its H2 growth projection to 7.4% from 7.3%, resulting in an unchanged FY25 growth estimate of 7.2%. However, there is a possibility that the RBI may have to lower the projection by December, potentially opening the door for rate cuts during that period.
The positive outlook for medium-term food inflation due to the robust monsoon has contributed to the RBI's favorable medium-term forecasts. The projected inflation rates for March 2025 and 2026 are a benign 4.2% and 4.1%, respectively. This is driven by expected deceleration in food prices and a lower oil price assumption of $80 per barrel compared to the previous estimate of $85 per barrel. The MPC's decision to adopt a neutral stance creates the possibility of reducing policy rates to ensure real rates are not excessively high, potentially hindering economic growth. The extent of potential rate cuts depends on various factors.
Based on the current projections for FY25 and FY26, real rates are significantly above the RBI's neutral rate range of 1.4-1.9%. Assuming sustained growth above 7% (7.2% in FY25 and 7.1% in FY26) as projected by the RBI, the higher end of the neutral rate range would necessitate a 50bps rate cut over the cycle. However, if global and domestic growth weakens, the neutral rate would likely fall closer to the midpoint of the range, potentially requiring a 75bps rate cut. The timing of any rate cuts is also a crucial consideration, with December odds exceeding 50%. The potential for weaker domestic growth, medium-term inflation aligning with the 4% target rate, and further rate cuts by global central banks bolster the case for a rate cut in December.
The shift to a neutral stance is likely to have a positive impact on liquidity conditions. Under the previous 'withdrawal of accommodation' stance, the RBI maintained tighter control over liquidity. However, the neutral stance allows for more accommodative liquidity conditions, facilitating faster responses to liquidity deficits and a higher tolerance for overnight rates staying within the Standing Deposit Facility (SDF) and the repo rate range. Several factors could potentially alter the current trajectory. Escalation of the Middle East conflict and Ukraine war would negatively impact markets and drive up oil prices, despite weak demand in China. A significant fiscal stimulus from China could lead to higher commodity prices and potential FPI outflows from India. Lastly, US presidential elections and economic policies could influence global growth and markets. The RBI's neutral stance provides the flexibility and optionality to adapt to evolving economic conditions as the growth-inflation dynamic changes.
Source: Neutral stance gives RBI freedom for managing liquidity