October MPC could provide a more balanced commentary on growth and inflation

By Samiran Chakraborty and Baqar Zaidi

The October Monetary Policy Committee (MPC) meeting will take place amid multiple global and domestic crosscurrents. It will also feature three newly-inducted external members whose approach to monetary policy will be closely observed in these rather uncertain times. The markets will be keenly waiting to find out whether the longest unchanged monetary policy stance of 19 months will finally pivot in the October meeting.

To start with, the external backdrop is more conducive now for some softening of the monetary policy. The triad of lower global interest rates, dollar and oil prices (compared to the August policy) would be comforting to the MPC, as in the not-so-distant past these factors were posing some difficult questions. Moderating global growth is also a favourable tailwind for policy easing.

That said, there are two key global uncertainties in front of the October MPC. First, it will have to assess the potential impact on commodity prices from the ongoing China stimulus, including the possibility of the stimulus extending to a large fiscal support. Second, the rising geopolitical tensions could unleash another wave of supply-side inflationary disruptions. It appears that these issues could keep the MPC cautious in its October meeting.

On the domestic front, there is both good news and bad news on inflation. The good news is that the last two inflation prints at ~3.6% year-on-year have been well below the Reserve Bank of India’s (RBI) mid-point target, and most of the exclusion-based core inflation measures have been benign for a substantial period. Consumer Price Index (CPI) ex-vegetable inflation fell to a 60-month low of just 3.07% in August. This suggests a ~20-30 basis point downside risk to the RBI’s Q2FY25 inflation forecast made in the August MPC meeting. Aggregate monsoon rains were above normal (108% of long-term average), and the government lifting the rice export ban suggests an expectation of decent food grain production. Based on these developments, the RBI’s model-based estimates now suggest headline CPI falling below the medium-term target of 4% from Q2FY26.

However, the bad news is that the next three inflation prints (September to November) are likely to be close to 5%, primarily due to unfavourable base effects. Elevated vegetable prices, any impact on the standing crop from late rainfall in September, and a few of the agricultural trade policy changes could pose upside risks too. After waiting for 19 months, it might be challenging for the RBI to start its rate-cutting cycle with risks of 5% inflation prints around the corner. The RBI has been arguing persistently that policy needs to be restrictive until inflation aligns durably towards the 4% target.

Another factor for the RBI delaying any rate easing has been the resilience of India’s growth. Despite a somewhat lower-than-expected Q1FY25 GDP print, the RBI’s recent model estimate puts full-year FY25 growth at 7.3%, broadly similar to August MPC’s 7.2% estimate. If the central bank maintains its GDP forecasts in the October meeting, there is not much urgency to ease monetary policy. On the other hand, some recent high-frequency activity data points have been marginally weaker. Along with global slowdown risks, these trends suggest that the MPC might gradually become more sensitive to the growth outlook too. Information from the festive season demand and the Q2 GDP data (to be released before the December meet) could throw more light on these developments. A challenge in interpreting the next few quarters’ GDP could also be the statistical issue of GDP growth falling below the gross value added growth due to the base effect from last year. Thus, the evolving growth dynamics could become a key trigger for the MPC to shift its policy bias.

The RBI has also been able to delay any policy easing because financial conditions are not tight by historical standards, despite its “withdrawal of accommodation” stance. Due to surplus banking system liquidity, money market rates are down 20-25 bps since the start of the year. The risk-free rates of government bond yields also fell due to lower supply pressure and increased demand from foreign portfolio investments. Weighted average lending rates on fresh loans are broadly unchanged from the same period last year and both nominal and real lending rates are much lower than the earlier cycle peaks. Even the real policy rate is not too far from the RBI’s estimate of the neutral rate, though the governor has de-emphasised a mechanical interpretation of neutral rates at the current juncture. Any softening of monetary policy now could ease financial conditions even more and lead to the potential risk of causing further froth in asset markets.

So, what are the policy options in front of the October MPC? It can be acknowledged that the delta of macro data (both growth and inflation) is slowly moving towards creating the right preconditions for a rate easing. But even then, October might be too early for a rate cut, as close to 5% headline inflation in the near-term could prove to be a big hurdle to overcome. The macro argument in following the Fed is not convincing enough as India’s macro stability parameters are quite comfortable and emerging markets central banks like the RBI have the flexibility to chart their own policy path. In our base case, while we expect the MPC to keep rates and its stance on hold in October, it could provide a more balanced commentary on growth and inflation, in line with the governor’s recent comments. In one of his speeches, he said “the balance between inflation and growth is well-poised” — a phrase he might repeat in the October policy. That said, we cannot rule out an outright change in stance to “neutral” from “withdrawal of accommodation” with a stronger guidance that rates could be kept on hold for an extended period, even with a “neutral” stance. While this would reduce the immediate pressure on the RBI to act on rates, there is a risk that the financial conditions would ease further based on that stance signal.

The writers are respectively the chief economist-India, and economist-India and Sri Lanka, Citi India.

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