Contrary to expectations that it might soften its stance with the US Federal Reserve expected to tighten its policy more aggressively, the Reserve Bank of India (RBI) made it clear in its bi-monthly monetary policy on Thursday that it would be guided more by domestic considerations.
At the same time, the RBI’s tone was a tad more hawkish as it chose to underpin its move to not loosen monetary policy, or alter its “withdrawal of accommodation” stance, citing that food inflation was turning out to be “stubborn”. The central bank would like to see food prices settle down sustainably as they have been persistent rather than transitory. It believes that disregarding food inflation could result in households’ expectations becoming unanchored which, in turn, could spill over to wages and core inflation, which has remained soft.
In fact, while the inflation forecast for FY25 was retained at 4.5%, the projection for the second quarter was raised by a fairly sharp 60 basis points (bps) to 4.4%, while for Q3, it was upped slightly to 4.7%. Governor Shaktikanta Das believes the pace of disinflation is uneven and, therefore, the 4% target is some time away. Having altered its assessment of neutral real rates from 0.8-1% to 1.4-1.9%, the central bank has given itself the space to keep rates unchanged.
While all of this may be justified, the central bank’s hawkish stance probably also has something to do with concerns around the high credit-deposit ratios at several lenders resulting from the gap between the growth in deposits and loans. Although risk weights for unsecured and personal loans were tightened last November, and credit to these segments has moderated, Das expressed concerns on “top-up loans”.
Also, there are worries over potential structural liquidity issues at banks. Lowering policy rates at this juncture, or allowing excess liquidity in the system, could drive funds to unproductive segments at a time when household savings are moving away from deposits.
What’s helping the central bank is the abundant liquidity in the system of more than Rs 2.5 trillion with government spending having resumed. Overnight rates have fallen some 20-25 bps since June and are near 6.5% levels. Bond yields, in general, have remained benign and are expected to stay at sub-7% levels. In fact, the central bank has been trying to pull out some of this liquidity but has refrained from putting out a calendar for open market operations.
The central bank also seems comfortable with growth; the GDP growth forecast for FY25 of 7.2% is higher than what most economists have forecast and higher than the 6.5-7% range assumed in the Economic Survey. The comfort is, however, mystifying given that private consumption — accounting for 56% of the economy — grew at just 4% in FY24. In fact, the GDP forecast for Q1 has been moderated to 7.1% on the back of some high-frequency indicators that indicate lower-than-anticipated corporate profitability.
While rural demand may be picking up, it is far from meaningful. Importantly, sales of commercial vehicles (CVs) at Tata Motors have contracted or grown marginally in all but one of the nine months to July: CVs are a cyclical indicator and the numbers signal the possibility of a slowdown. The RBI, it seems, is buying time till it has a better sense of the kharif crop and food prices. Even if policy rate cuts materialise in December, the quantum would be small.