We have been talking about the Reserve Bank of India (RBI) easing interest rates for quite some time. The question now is: what is the appropriate time for the RBI to initiate this? The latest meeting of the central bank’s Monetary Policy Committee (MPC) was on 6 December. Earlier, there were expectations that the rate easing cycle would be initiated at this review meeting.
However, inflation figures for October, released on 12 November, were a dampener. Inflation came in at 6.21%, higher than the markets expected and above the RBI’s tolerance limit of 6%. Against this backdrop, the 6 December meeting was expected to provide clues about future action on rates. While policy rates were left unchanged as expected, there were quite a few points worth noting from the meeting.
Liquidity boost
The cash reserve ratio (CRR) is the amount of money that banks must park with the RBI, on which the central bank does not pay any interest. CRR, which was 4.5% deposits with banks, is now being reduced to 4%. This will release a chunk of money into the banking system – about ₹1.16 trillion. The reason for the CRR reduction is that banking system liquidity was under pressure as foreign portfolio investors (FPIs) made sizable exits in October and November. Now that banks have to park less money with the RBI, day-to-day liquidity in the banking system will improve.
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Banking system liquidity moves between surplus and deficit depending on various parameters. The RBI controls or at least influences it. In the previous policy review on 9 October, the RBI changed its stance on interest rates from “withdrawal of accommodation” to neutral. This was a positive move from the market’s perspective. Combining the two – the change of stance and the CRR cut – we can say the RBI is now amenable to interest rate easing.
Inflation rises, growth projections fall
Other aspects of note in the MPC review of 6 December are the revised outlooks on inflation and GDP growth. Before the 9 October review meeting, the RBI had projected CPI inflation at 4.5% in FY25. This has now been raised to 4.8%. Given that inflation for October was on the higher side, such a revision was due. The other important variable is the GDP growth rate. Until the October review, the RBI projected a growth rate of 7.2% for FY25. However, growth for the September quarter came in at 5.4%, below the lowest forecasts by economists. In light of that, the RBI has now reduced its growth projection for FY25 to 6.6%.
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The most important variable to consider for the repo rate, currently at 6.5%, is inflation. The target for consumer price index (CPI) inflation is 4%, with a tolerance band of plus or minus 2%. Though the RBI has raised its inflation projection for the year to 4.8%, it is within the tolerated range, and nearer to the target of 4%. In April-June 2025 CPI inflation is expected to ease to 4.6%, and in July-September 2025 it is expected to hit the 4% target. From this perspective, the current quarter, October-December 2024, is a blip and things will improve from here on.
The other aspect of note in the MPC meeting was the voting pattern. At the previous meeting on 9 October, the vote was 5:1 with one member voting for a 25 basis points (0.25 percentage point) rate cut. At the 6 December meeting, the vote was 4:2, with two members voting for a 25 basis points cut. The concern here is growth. India’s GDP growth rate of 6.5% to 7% is not bad, but is slowing at the margin. Policymakers should thus ease interest rates to support growth.
Conclusion
It is now over to the next review meeting on 7 February 2025, at which the voting pattern must change to 4:2 in favour of a rate cut. With the tenure of the current RBI Governor coming to an end, the views of the next governor will affect forthcoming decisions. Overall, with expectations of a policy rate cut, the environment is conducive to investments in equity and debt.
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Joydeep Sen is a corporate trainer (financial markets) and author.
