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The Reserve Bank of India (RBI) is widely anticipated to maintain its benchmark repurchase rate at 6.5% during its upcoming monetary policy committee meeting. This decision comes amidst a backdrop of conflicting economic indicators: sluggish growth and persistent inflation. While a majority of economists polled by Bloomberg predict a status quo on interest rates, the unexpected decline in India's GDP growth to 5.4% in the July-September period has ignited a debate about the central bank's approach. The slower-than-expected growth has fueled concerns that the RBI's restrictive policies, implemented to curb inflation, may be inadvertently hindering economic activity.
The divergence between economic growth and inflation presents a significant challenge for the RBI. While inflation remains above the central bank's 4% target, with October's figure reaching 6.2% due largely to volatile food prices, the weakening GDP growth rate is pushing for a more accommodative monetary policy. This pressure is further intensified by calls from Finance Minister Nirmala Sitharaman and Commerce Minister Piyush Goyal for lower borrowing costs, echoing the sentiment of several economists who advocate for increased lending to stimulate growth. The upcoming announcement is particularly crucial for RBI Governor Shaktikanta Das, whose six-year term ends next week, adding another layer of complexity to the decision-making process, given the uncertainty surrounding his potential reappointment.
Market indicators suggest an expectation of a future rate cut, with bond yields and swap rates declining, reflecting investor sentiment. Economists at Nirmal Bang Institutional Equities Ltd. believe a shift in the MPC's policy narrative is unavoidable, necessitating acknowledgement of the growth slowdown and the need for counter-cyclical support. While they predict a rate cut only in the following year, they do not entirely dismiss the possibility of a surprise move during the current meeting. The significant miss in the second-quarter growth estimates (160 basis points) has jeopardized the RBI's earlier projection of 7.2% GDP growth for the fiscal year ending March 2025. Consequently, economists have revised their projections downward, with Goldman Sachs Group forecasting a 6% expansion, down from its previous 6.4% estimate.
The RBI's dilemma is compounded by the rising inflation. The current growth-inflation divergence creates a challenging situation for the MPC, as noted by DBS Bank Ltd. economist Radhika Rao. She anticipates the RBI will lower its full-year growth projection by 30-40 basis points and simultaneously raise its inflation outlook from the current 4.5%. This expectation reflects the delicate balancing act the RBI must perform to address both inflation and growth concerns simultaneously. The October review saw external member Nagesh Kumar advocating for a quarter-point rate reduction, and with growing calls for similar action, more MPC members may join him in this stance. Emkay Financial Services Ltd. economist Madhavi Arora anticipates at least two members voting for a rate cut to bolster growth.
Adding further complexity to the policy outlook are recent capital outflows and pressure on the exchange rate. The rupee's decline to new lows increases the risk associated with monetary easing, as such a move might exacerbate the situation by lowering the interest rate differential with the US. Liquidity conditions are currently tight due to the central bank's significant foreign exchange intervention and currency leakage from the banking system. The core banking system liquidity surplus is estimated to have fallen to ₹1.2 trillion from ₹4.5 trillion at the end of September. To alleviate this tightness, analysts anticipate the RBI will reduce the cash reserve ratio (CRR), the percentage of deposits banks must hold as cash reserves with the central bank. This move, considered a soft signal for future monetary easing, is expected to improve liquidity in the banking system.
Beyond CRR adjustments, other liquidity measures are also being considered. Longer-term repo windows are also a possibility as indicated by Churchill Bhatt, executive vice president for debt at Kotak Mahindra Life Insurance Ltd. The market is actively pricing in potential changes, as reflected by the decline in overnight indexed swaps (OIS) and five-year swaps. The upcoming policy press conference is expected to be filled with questions regarding Governor Das's potential extension or the selection of his successor, given that his term ends on December 10th. The lack of clarity on this matter adds another layer of anticipation surrounding the RBI's policy decisions.