We have been talking about a rate cut by the Reserve Bank of India (RBI) for quite some time now. The question now is, when is the right time for the RBI to start doing this? The last meeting of the central bank’s Monetary Policy Committee (MPC) was on December 6. Previously, it was expected that the interest rate easing cycle would get underway during this review meeting.
However, the inflation figures for October, published on November 12, were a dampener. Inflation came in at 6.21%, higher than markets expected and above the RBI’s tolerance limit of 6%. Against this background, the December 6 meeting was expected to provide clues on future action on interest rates. Although policy rates remained unchanged as expected, there were quite a few points worth mentioning during the meeting.
Liquidity boost
The cash reserve ratio (CRR) is the amount of money that banks have to park with the RBI, on which the central bank does not pay interest. CRR, which consisted of 4.5% deposits with banks, will now be reduced to 4%. This will allow some of the money to flow into the banking system – approximately ₹1.16 trillion. The reason for the cut in the CRR is that the liquidity of the banking system was under pressure as foreign portfolio investors (FPIs) made significant exits in October and November. With banks having to park less money with the RBI, day-to-day liquidity in the banking system will improve.
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The liquidity of the banking system moves between a surplus and a deficit, depending on various parameters. The RBI controls or at least has influence over it. In the previous policy review on October 9, the RBI changed its stance on interest rates from “withdrawal of easing” to neutral. This was a positive step from the market’s perspective. Combining these two – the change in stance and the cut in CRR – we have been able to say that the RBI is now amenable to easing rates.
Inflation is rising, growth expectations are falling
Other aspects covered in the December 6 MPC review include the revised outlook for inflation and GDP growth. Before the October 9 review meeting, the RBI had forecast CPI inflation for FY25 at 4.5%. This has now been increased to 4.8%. Since inflation was on the higher side in October, such a revision was appropriate. The other important variable is GDP growth. Till the October review, the RBI had forecast a growth rate of 7.2% for FY25. However, growth for the September quarter came in at 5.4%, lower than economists’ lowest expectations. In light of this, the RBI has lowered its FY25 growth projection to 6.6%.
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The main variable to consider for the repo rate, which currently stands at 6.5%, is inflation. The target for consumer price index (CPI) inflation is 4%, with a tolerance margin of plus or minus 2%. While the RBI has raised its inflation projection for the year to 4.8%, it is within the allowable range and closer to the 4% target. In April-June 2025, CPI inflation is expected to decline to 4.6%, and in July-September 2025 it is expected to reach the 4% target. From this perspective, the current quarter, October-December 2024, is a blip and things will improve from here on out.
The other striking aspect of the MPC meeting was the voting pattern. At the previous meeting on October 9, the vote was 5:1, with one member voting for a 25 basis point (0.25 percentage point) rate cut. At the December 6 meeting, the vote was 4:2, with two members voting for a 25 basis point cut. This is about growth. India’s GDP growth of 6.5% to 7% is not bad, but slowing at the margin. Policymakers must therefore lower interest rates to support growth.
Conclusion
It is now time for the next review meeting on February 7, 2025, where the voting pattern should change to 4:2 in favor of an interest rate cut. As the current RBI governor’s term comes to an end, the views of the next governor will influence upcoming decisions. Overall, given expectations of a policy rate cut, the environment is conducive to equity and debt investment.
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Joydeep Sen is a business trainer (financial markets) and author.
