Given India's complex economic environment, there is growing pressure on the Reserve Bank of India (RBI) to revise its monetary policy to boost growth and control inflation. Ahead of the RBI's December meeting, the main topic on everyone's mind is whether the central bank will reduce interest rates.
Economists and analysts have varying opinions on the matter; some believe a cautious approach is more likely, while others predict a rate cut as early as December. Here's a closer look at the factors influencing the RBI's monetary policy and what to expect in December.
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The Economic Slowdown and Inflation Concerns
India's GDP growth for the July-September quarter was just 0, indicating that the country's economic growth is slowing. This was well below forecasts and has raised questions about how effective the RBI's previous policy initiatives have been. The central bank must strike a balance between boosting economic growth and managing inflation in such a recessionary period.
Meanwhile, inflation is still high, particularly as food costs are rising. Inflation rose to 6.2% in October, the highest in more than a year, well above the RBI's tolerable limit of 6%. As a result, the RBI's decision-making process is now more complicated. Keeping inflation at the 4% target is the central bank's main duty, but it must also take into account the potential long-term effects of higher borrowing costs on GDP.
Nomura's Bold Prediction: 100 Basis Points Rate Cut
Some financial firms expect that the RBI may be forced to soften its stance on interest rates despite inflation concerns. At the start of the December meeting, Japanese investment bank Nomura took a bold step and predicted a rate cut of 100 basis points (bps). Compared to the prevailing view, which expects a less than 50 bps drop or no change at all, my forecast is more aggressive. Additionally, Nomura lowered its GDP growth forecast for FY25 to 6%, which is lower than the RBI's October forecast of 7.2% and the consensus.
Although this is a remarkable forecast, it is important to remember that most economists do not share this view. According to consensus, the RBI is unlikely to reduce rates in December due to persistent inflation concerns, especially given the volatility of food prices. However, given the difficulties presented by poor GDP data, it is impossible to completely rule out the possibility of a rate cut.
What to Expect from the RBI’s December Meeting
It is expected that the Reserve Bank's Monetary Policy Committee (MPC) will maintain the current interest rate status quo in its monetary policy meeting on December 6. According to a recent media survey, most analysts (70%) believe that the RBI will keep the repo rate at 6.5% for the eleventh consecutive meeting.
The RBI is not expected to risk further tightening of policy, which could increase the GDP decline, even if inflation remains above the target. However, the tone of RBI Governor Shaktikanta Das may be an important component of this discussion.
While a rate cut is not expected right now, the policy statement may change that. In the upcoming policy meeting in February 2024, Governor Das may address growth issues more openly, which could pave the way for a rate cut.
One Option is a Reduction In Cash Reserve Ratio (CRR)
Since inflationary pressures are still high, some analysts believe the RBI could increase liquidity in other ways without lowering interest rates. Lowering the cash reserve ratio (CRR), which is the ratio of banks' deposits with the RBI to their capital, is one option.
A reduction in the CRR would give banks more capital, allowing them to make larger loans and perhaps boost the economy. Economists disagree on whether a reduction in the CRR is likely.
While some anticipate the RBI will take such a step to ease the banking system's liquidity restrictions, others believe it may wait until next year. The RBI's assessment of the trade-off between controlling inflation and promoting growth will determine this choice.
The RBI’s GDP and Inflation Forecasts
Apart from the rate decision, the RBI's new economic forecasts will also be closely scrutinized. Many experts anticipate that the RBI will lower its GDP forecast for FY25, originally set at 7.2% in October, in light of the current slowdown in growth.
Some estimates put it as low as 6%, but the most recent GDP data indicate a cut to 6.4%-6.7% is possible. This would be in line with a more conservative growth strategy that recognizes the possibility of a prolonged recession.
Citing concerns over food cost fluctuations, half of the economists surveyed believe the RBI will raise its inflation forecast for FY25 from the current estimate of 4.5%. Since the RBI's inflation forecast will influence future expectations, this will be another important aspect to monitor.
Market Expectations Centered on Liquidity
Traders and experts are also closely tracking the RBI's potential liquidity measures apart from the rate decision. The financial system has been hit by severe liquidity problems, partly due to capital outflows and foreign exchange manipulation. Pressure on the banking industry has increased as the core banking system's liquidity surplus fell from Rs 4.5 trillion to barely Rs 1.2 trillion by the end of September.
The RBI may consider using long-term repos or other methods to infuse cash to ease liquidity difficulties. Additionally, a potential CRR cut would signal that the RBI is getting ready to adopt a more accommodative stance in the coming months.
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