The last couple of days have been probably very difficult for the Reserve Bank of India’s monetary policy committee (MPC). On the one hand, there was the sharper than expected slowdown in the GDP growth in the July-September quarter, which perhaps warranted a cut in interest rates. But, there was also the resurgence in retail inflation that couldn’t be ignored either. Ultimately, the MPC decided to leave the repo rate unchanged at 6.50 per cent, as was widely expected. It also maintained a neutral stance, which would give it flexibility to act if and when needed.
RBI Governor Shaktikanta Das pointed out that the central bank’s anti-inflationary monetary policy stance had been a crucial factor in bringing about significant disinflation. While the gains achieved so far in controlling inflation needed to be “preserved” the trajectory around growth and its evolving outlook also needed to be “monitored closely”, he said.
“At this critical juncture, prudence and practicality demand that we remain careful and sensitive to the dynamically evolving situation with all its complexities and ramifications. A status quo in monetary policy in this meeting of the MPC has thus become appropriate and essential,” stressed Das.
But, even as it left the benchmark rate at which it lends money to commercial banks unchanged, it, as some had expected, decided to slash the CRR (cash reserve ratio) by 50 basis points to 4 per cent. CRR is the percentage of total deposits that each bank must maintain in cash. The move to cut CRR frees up some of this liquidity.
More importantly, the central bank has now sharply lowered its GDP growth forecasts for the current financial year to 6.6 per cent from 7.2 per cent, while the inflation forecast was also slightly raised.
A steady rise in inflation driven by price hikes
Driven by high food prices, CPI (consumer price index) inflation in October jumped to a 14-month high of 6.21 per cent from 5.49 per cent in September. According to RBI’s projections, as food price shocks wane, headline inflation is likely to ease and realign with RBI’s targeted 4 per cent.
The estimates of a record Kharif crop production are expected to bring relief to the elevated prices of rice and tur dal. On the other hand, vegetable prices are also expected to see a seasonal winter correction. But at the same time, the evolving trajectory of domestic edible oil prices, following the hike in import duties and rise in their global prices, will have to be closely monitored.
Against this backdrop, the RBI now expects CPI inflation to average 4.8 per cent in the current financial year ending March 2025; this is higher than its earlier forecast of 4.5 per cent. Given the recent inflation spike, the forecast for the October-December quarter has been raised sharply to 5.7 per cent from the 4.8 per cent it had expected earlier. CPI inflation in the January-March is now projected at 4.5 per cent, compared with earlier expectations of 4.2 per cent.
“High inflation reduces the disposable income in the hands of consumers and dents private consumption, which negatively impacts the real GDP growth. The increasing incidence of adverse weather events, heightened geopolitical uncertainties and financial market volatility pose upside risks to inflation. The MPC believes that only with durable price stability can strong foundations be secured for high growth,” stressed Das.
India’s second quarter (July-September) GDP growth slowed to a seven-quarter low of 5.4 per cent. This was much lower than the RBI’s expectation of GDP growing by 7 per cent in that quarter. Given this deceleration in growth, the central bank has now revised its full-year (2024-25) GDP forecast downwards to 6.6 per cent from 7.2 per cent. It projects GDP to pick up to 6.8 per cent in the December quarter and then rise further 7.2 per cent in the March quarter.
“High-frequency indicators available so far suggest that the slowdown in domestic economic activity bottomed out in Q2 2024-25 and has since recovered, aided by strong festive demand and pick up in rural activities,” pointed Das.
He also noted that agriculture growth was supported by healthy kharif crop production, higher reservoir levels and better rabi sowing. Industrial activity is also expected to normalise and recover. The Reserve Bank also expects the government’s capital expenditure to pick up, which, coupled with the end of the monsoon, is expected to provide some impetus to the cement, and iron and steel sectors.
On the demand side, it was noted that while urban demand showed some moderation on a high base, rural demand trended upwards, government consumption improved, and investment activity was also expected to improve.
While the MPC chose to leave the repo rate unchanged, it did decide to cut the CRR of all banks to 4 per cent; this is the rate that was prevailing before the interest rate tightening cycle began in April 2022. The move, which will be in two tranches of 25 bps cuts, will be effective from the fortnight beginning December 14 and December 28. The CRR cut is expected to release primary liquidity of about Rs 1.16 lakh crore in the banking system.
“Even as liquidity in the banking system remains adequate, systemic liquidity may tighten in the coming months due to tax outflows, increase in currency in circulation and volatility in capital flows. To ease the potential liquidity stress, it has now been decided to reduce the cash reserve ratio,” said Das.
He maintained that the financial parameters of banks and NBFCs continued to be strong, and incoming data suggested that the gap between the growth of credit and deposits of scheduled commercial banks had narrowed, with deposits keeping pace with loan growth.
The Reserve Bank’s supervision of the financial sector and its entities continued to be vigilant and proactive; any incipient signs of stress, if any, either at the systemic or entity levels, are monitored closely and proactive action is initiated, he added.