Horse may simply bolt again... Why RBI left repo rate unchanged again, even as it turned neutral

The Reserve Bank of India's monetary policy committee (MPC) on Wednesday left the repo rate unchanged at 6.5 per cent as was widely expected. However, while it left the benchmark rate at which it lends commercial banks on hold for the 10^th time in a row, the MPC unanimously decided to change the stance to "neutral" and to remain "unambiguously focused"on a durable aligning of inflation with the target.

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Over the past month, several major global central banks, including the Federal Reserve, the European Central Bank (ECB) and the central bank in China had slashed their interest rates as supporting economic growth gained currency.

Domestically, India's GDP growth has remained stable, while CPI (consumer price index) inflation in July and August had trended below the central bank's targeted 4 per cent. The monsoon has been good this year, which ideally should aid agriculture as well as the rural economy. Why did then the MPC still choose to leave interest rates unchanged?

RBI Governor Shaktikanta Das noted that moderation in headline inflation is expected to reverse in September and likely to remain elevated in the near-term due to adverse base effects, among other factors. While food inflation pressures could see some easing later in this financial year, aided by strong kharif crop sowing, adequate buffer stocks and good soil moisture conditions conducive for rabi sowing, adverse weather events continue to pose contingent risks, he said. Geopolitical conflicts too remained a risk, he pointed out.

Therefore, the MPC chose to keep the rates on hold, remaining watchful of the evolving inflation outlook.

"It is with a lot of effort that the inflation horse has been brought to the stable, i.e., closer to the target within the tolerance band compared to its heightened levels two years ago. We have to be very careful about opening the gate as the horse may simply bolt again," said Das.

He stressed on the need to keep the horse under "tight leash" so that they don't lose control.

But even as the MPC remained firm on interest rates, it found it appropriate to change the stance to "neutral," from "withdrawal of accommodation" signalling it could act in future, should conditions turn conducive.

"The monetary policy action today reflects the MPC’s assessment that, at the current juncture, it would be appropriate to have greater flexibility and optionality to act in sync with the evolving conditions and the outlook," said Das.

The RBI has left its full year (2024-25) CPI inflation target at 4.5 per cent, unchanged from its projection in August. Retail inflation in July was at 3.6 per cent and at 3.65 per cent in August.

The central bank expects inflation to average 4.1 per cent in the July-September quarter, rising to 4.8 per cent in October-December and cooling again to 4.2 per cent in January-March.

The RBI also left its GDP projections for the current financial year ending March 2025 unchanged at 7.2 per cent. It sees GDP at 7 per cent in the second quarter, and 7.4 per cent in the third quarter as well as the fourth quarter.

The prevailing and expected inflation-growth balance created "congenial conditions" for a change in monetary policy stance to "neutral," said Das.

"Even as there is greater confidence in navigating the last mile of disinflation, significant risks to inflation from adverse weather events, accentuating geopolitical conflicts and the very recent increase in certain commodity prices continue to stare at us. The adverse impact of these risks cannot be underestimated," he stressed.

Many economists had widely expected the RBI MPC to keep the repo rate on hold and start cutting rates from December. Governor Das, while stating the Indian economy presents a picture of stability and strength, also stated that there was still a distance to cover on the inflation front. The expectation would now be that food prices cool in coming months aided by a good monsoon and harvest, which should then possibly open the doors for a rate cut, at a time, slowing demand in areas like passenger vehicles have cast shadows on near-term growth.