Monetary Policy Preview: Will The RBI Maintain Status Quo?

The Reserve Bank of India's (RBI’s)  Monetary Policy Committee (MPC), reconstituted with new external members, is set to meet this week. CareEdge Ratings anticipates that the MPC will maintain the current policy rate and stance. Inflationary risks have not fully abated, specifically concerns around food inflation continue to linger. 

Although economic growth has been healthy, there are some early signs of softness. The commentaries from the newly inducted external members will be closely monitored to gauge future policy directions. “Overall, we expect the governor to have a dovish tone, laying the groundwork for a shallow rate cut in the coming months,” CareEdge Ratings stated.

The agency stated that the MPC will be cautious regarding the evolving risks of food inflation. Although core inflation has remained relatively benign, higher food inflation has kept the headline numbers elevated. As far as economic growth is concerned, while high-frequency indicators suggest some softening of the economic momentum, overall growth continues to remain healthy. 

A revival of the private consumption demand along with early signs of a pickup in private investment bodes well for the overall economy. The RBI will also find comfort in the fact that growth in unsecured lending has slowed, it added. 

“We believe that RBI is likely to maintain a status quo on policy interest rates in the upcoming meeting. However, if food inflation moderates, we could see a shallow rate cut of 50 bps in the upcoming policy meetings in this fiscal year,” it mentioned.

Risks To Inflation Remain
Despite inflation remaining below 4 per cent over the past two months, primarily due to a favourable base and some sequential slowdown in food prices, the risk of food inflation remains high. Although the monsoon was approximately 8 per cent above normal, distribution issues persisted, with lower rainfall in key agrarian states in North India (Punjab and Haryana) and Eastern states (Bihar, Eastern UP and Gangetic West Bengal) during the sowing season. 

Kharif sowing for pulses and some oilseeds has been below the historical average, which is concerning. 

Additionally, the extended monsoon season and recent pre-harvest showers increase the risk of crop damage. Given these developments, the risk of food inflation has not been fully mitigated and will remain a concern for the RBI, according to the CareEdge Ratings.

The base effect of food inflation is expected to turn adverse in the coming months, further contributing to an increase in food inflation in the coming months.

Beyond food price pressures, additional inflation risks arise from the external sector. The potential for a broadening conflict in the Middle East could disrupt supply chains and impact global energy prices, which would have ripple effects on the domestic economy. 

Furthermore, the announcement of economic stimulus in China has led to an increase in global commodity prices, particularly industrial metals, over the past month. Industrial metal prices have risen by 8 per cent over the past one month and Brent crude prices have recovered from their lows of USD 70 per barrel in early September to USD 77 per barrel. 

Core inflation and WPI inflation have remained largely benign averaging 3.3 per cent and 2.1 per cent respectively in FY25. However, the recent rise in global commodity prices can be passed on to the WPI basket and needs to be monitored, it added.

The MPC members will closely monitor the evolving inflationary dynamics and will prefer to see more data points indicating a durable easing of price pressures. Having said that the MPC is likely to retain its inflation projection of 4.5 per cent for FY25.

MPC May Not Follow Global Central Banks 
Since the last RBI’s policy meeting in August, major global central banks have initiated a rate-cutting cycle. Recently, the US Federal Reserve reduced its policy rate by 50 basis points in September. Similarly, other central banks, including the European Central Bank (ECB), the Bank of Canada, and the Bank of England, have also lowered their policy rates. 

MPC members will also take cognizance of the recent escalation in the geopolitical tensions in the Middle East. The rate cuts by major global central banks may not translate into the RBI toeing a similar path. 

The RBI governor has repeatedly highlighted that the RBI’s policy actions would be primarily driven by deliberations on the domestic economy’s growth-inflation dynamics. Having said that the recent Fed rate cuts will limit pressure on the rupee and provide a window to MPC members to undertake future rate cuts as inflation moderates.

The current account deficit remained comfortable at 1.1 per cent of gross domestic product (GDP) in Q1FY25. While merchandise exports contracted in both July (-1.7 per cent YoY) and August (-9.3 per cent YoY), it is counteracted by a growing services export. Services exports growth averaged 11 per cent in July to August. FPI inflows remained strong with a total inflow of USD 15.5 billion in the fiscal year so far, supported by India’s index inclusion in major bond indices. 

It stated that the overall external situation remains comfortable with FX reserves surpassing USD 700 billion.