October Monetary Policy: Status Quo On Rate; Stance Too May Not Change

In its August meeting, the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) decided to maintain the status quo — keeping both the policy rate and stance unchanged. The Indian central bank had shown no concern over growth and no comfort on inflation, resulting in the ninth consecutive pause.

The repo rate — at which the RBI lends to banks — remained unchanged at 6.5 per cent. The stance also stayed as "withdrawal of accommodation" to ensure that inflation aligns with the target while supporting growth.

What has changed since then?

Well, the MPC has been reconstituted with three new external members. Will the new MPC signal a shift, at least in the policy stance?

Globally, central banks' approaches?are varying, reflecting different stages in the fight against inflation across regions.

In September, the US Federal Reserve announced its first rate cut since the early days of the Covid pandemic, lowering the Fed funds rate by half a percentage point to 4.75-5 per cent. This was the first half a per cent?cut?since the global financial crisis of 2008, excluding the pandemic period. Last week, Federal Reserve Chair Jerome Powell hinted at more interest rate cuts, though the timing and scale would depend on economic developments. The Fed’s "dot plot", which records projections of each of the 12 members of the Federal Open Market Committee, its rate-setting body, suggests four more quarter percentage point cuts in 2025 and two more in 2026.

Eurozone inflation dipped below 2 per cent in September for the first time since mid-2021, raising the possibility of yet another rate cut by the European Central Bank (ECB). Inflation in the 20-country bloc eased to 1.8 per cent, lower than what most analysts had expected. Last month, the ECB cut its rate by a quarter percentage point to 3.5 per cent, following a similar move in June.

Meanwhile, analysts expect the Bank of England to announce a rate cut in November. In September, the Bank held rates steady at 5 per cent,?and?Governor Andrew Bailey?indicated?that rates would "gradually be on the path down". Inflation had "come down a long way," but Bailey emphasised the need for more evidence before reducing rates.

In emerging markets, central banks in the Philippines and Indonesia also cut rates. For the Philippines, it was the first cut since November 2020;?the last time Indonesian central bank cut rate was in February 2021.

While Indonesia’s rate cut was a surprise, the People's Bank of China's recent move was anticipated. It cut the reserve requirement ratio by half a percentage point and lowered interest rates to stimulate growth in the world's second-largest economy. On the other hand, central banks in Russia, Japan, and Brazil have increased rates as they continue battling high inflation.

What to expect from the RBI this week?

Retail inflation, which dropped to 3.6 per cent in July, rose slightly in August to 3.65 per cent, still below the RBI’s flexible inflation target (4 per cent, with a 2-percentage-point band on either side). The July and August inflation data had the advantage of a high base effect. The September retail inflation figure, expected to be at least 5 per cent, will be released after the policy.

At the same time, real GDP growth in the first quarter of 2024-25 (FY25) slowed to 6.7 per cent, the lowest in five quarters and below the RBI's estimate. However, it remains higher than the average first-quarter decadal growth of 6.4 per cent.

In early September, during an event organised by the Federation of Indian Chambers of Commerce and Industry and Indian Banks’ Association, RBI Governor Shaktikanta Das said, "the balance between inflation and growth is well-poised". He was optimistic about food inflation, suggesting it could become more favourable over the year.

Food prices, accounting for 46 per cent of retail inflation, have been a persistent concern for the RBI. There is ongoing debate over whether food prices should be excluded from inflation calculations, given that monetary policy cannot directly address supply-side shocks causing high food inflation. Meanwhile, core inflation — excluding food and oil — has been hovering at its lowest levels since the metric's inception in 2012.

The 2024 monsoon ended with 7.6 per cent more rainfall than normal, which should ease food inflation gradually. On the other hand, the rise in core inflation is expected to be gradual. Before the recent crude oil price spike following Iran's missile attack on Israel, oil prices had dropped 17 per cent during the July-September quarter due to declining global demand.

Given these dynamics, many expect that?while new MPC will continue to maintain the status quo on rates, the monetary policy stance could shift?to "neutral" with a more dovish tone.

However, I will not be surprised if the RBI remains in wait-and-watch mode, given the many uncertainties on multiple fronts.

The RBI has been repeatedly emphasising that its policy rate trajectory would be driven by domestic factors, not by the US Federal Reserve. Interestingly, despite the deep Fed rate cut, the difference between the policy rate in the US and India at the moment is much lower than the long-term average.

More than monetary easing, the fiscal stimulus unleashed by China needs to be taken into account, as this could impact commodity prices. The total size of China’s stimulus package this year, including the recent tranche, is estimated at around 7.5 trillion yuan ($1.07 trillion), equivalent to 6 per cent of China's GDP in 2024, a recent Deutsche Bank research note has said.

Even though the monsoon has been above normal, the distribution of rainfall is uneven, and?anecdotally?there are signs of rising food inflation.

Add to these the fast-evolving geopolitical scenario. While the Russia-Ukraine war is still on, the conflict in West Asia is deepening. It will not be surprising if the Indian central bank decides to wait until December to act. Anyway, there is adequate liquidity in the system, and the stance of “withdrawal of accommodation” doesn’t mean much.

In the last policy, the RBI's growth and inflation estimates for the current fiscal year remained largely unchanged but were fine-tuned. For instance, the real GDP growth forecast for FY25 stayed at 7.3 per cent, but the first-quarter projection was trimmed from 7.3 per cent to 7.1 per cent.

Similarly, the retail inflation estimate for the year was held steady at 4.5 per cent, but the second-quarter forecast was increased from 3.8 per cent to 4.4 per cent, the third-quarter estimate went up from 4.6 per cent to 4.7 per cent, and the fourth-quarter projection was cut from 4.5 per cent to 4.3 per cent.

Will there be any changes to these estimates? It seems unlikely that the inflation forecast will be adjusted even though many believe retail inflation in the last quarter of the year will be lower than projected. Regarding growth,?the RBI appears most bullish among all agencies. However, it could wait until December to revise both.

Between May 2022 and February 2023, the policy rate was raised by 2.5 percentage points. Since then, there has been a pause. Indeed the growth-inflation dynamics are shifting gradually but the RBI may not be in a hurry to act.

This column first appeared in Business Standard. The write, a Consulting Editor of Business Standard, is a Senior Adviser to Jana Small Finance Bank.Writes Banker's Trust every Monday in Business Standard.Latest book?Roller Coaster: An Affair with Banking

Twitter: TamalBandyo

Website:?https://bankerstrust.in

?