By Anubhuti Sahay
It can be expected that India’s Monetary Policy Committee (MPC) will keep the repo rate unchanged at 5.25% at its February 6 meeting. While the upcoming base year revision in the consumer price index (CPI) can potentially provide space to cut rates one more time in FY27, we believe other factors (risk of limited transmission, continued weakening pressure on the INR, a still-strong growth, and a need to build buffers amid an uncertain global environment) dilute the case for further rate cuts. In our view, the Reserve Bank of India’s (RBI) focus will remain (as has been the case in the recent past) on the provision of adequate liquidity to ensure that market rates remain aligned with the repo rate. The Indian rupee liquidity injection (to offset FX outflows) via bond purchases is also likely to contain the rise in bond yields (though yield management is not the main objective). Bond yields face upside pressure amid larger-than-expected borrowing for FY27.
We discuss the rationale for our views below
The base year revision in CPI is likely to provide space to cut one final time. The ministry of statistics and programme implementation will release the new CPI series with a revised base year of 2024 on February 12. Thus, we think the MPC is likely to await full clarity on the FY27 inflation trajectory in the new series before taking any further rate action at this week’s meeting.
Our simple analysis (by applying new weights to the existing sub-indices level) shows that in the new CPI series, FY27 headline inflation could be lower by 30-40 basis points (bps) versus our current forecast of 4.1%, ceteris paribus. However, as expanded coverage, methodological changes, etc., would also have an impact on the final CPI inflation, it is important to wait rather than act based on assumptions. If FY27 inflation turns out to be in line with our estimate, based on the real rate preference of 100-150 bps, room for one more rate cut could emerge. But the availability of space to cut rates does not warrant a need to use it just as of now.
We say so for several reasons
The ultimate objective of any monetary policy easing is transmission. We believe that better transmission or keeping money market rates closer to the repo rate can work more effectively with a focus on adequate liquidity provision. Another rate cut is likely to have a limited impact, especially if the market views the next move after a pause as a hike. For instance, since the last rate cut in December, while call rates have remained similar to where they were before the cut, 10-year bond yields have moved up on inadequate liquidity and an unfavourable bond supply-demand balance in FY27; the government announced a larger-than-expected gross borrowing programme in the recent budget. Recent RBI actions on liquidity are reassuring and liquidity provision via various tools (including bond purchases) will remain a key factor in keeping market rates anchored (rather than a rate cut).
Usually, interest rate differentials matter less for the Indian rupee, but at a certain juncture they become important. By no means are we suggesting that the Indian rupee needs any interest rate defence mechanism as of now. India’s import cover remains healthy at c.10 months and the RBI’s decision to allow the Indian rupee to be a shock absorber amid weak capital inflows is commendable. Capital flows remain weak on a host of factors, including a plunge in net foreign direct investment (FDI) to $1 billion in FY25 from a peak of $40 billion in FY20. Higher global rates, the incentive to invest in artificial intelligence (AI), and a slower-than-expected revival in domestic demand are the likely reasons for this sharp fall in net FDI flows. While both the RBI and the government are focused on attracting durable capital flows back to the economy, it is likely to come with a lag as structural reforms (key to boosting return on capital in India) take time to implement and yield gains. In the interim, another rate cut is likely to further de-incentivise USD raising amid higher global rates. Maintaining the policy rate at least takes off additional pressure on the Indian rupee and the import bill.
Moreover, geopolitical tensions, trade fragmentation, and concerns on AI-focused investment flows raise external risks for India. Hence, it is important to build buffers to manage these risks in case they materialise. Crude oil prices have quietly inched up towards $67 per barrel (after touching $70 briefly) and there are upside risks to base metal prices. Should these risks materialise, especially amid a weaker Indian rupee, it could push inflation higher. Thus, a wait-and-watch mode makes more sense than a cut followed by a quick turnaround in the monetary policy cycle. At the same time, in case of any adverse shocks to growth later in the year due to external factors, keeping some powder dry in the form of policy rate cuts can help.
A steady growth environment provides space to wait rather than rushing to deliver the final rate cut (if there is one). We expect India’s GDP growth to moderate to 6.6% in FY27 from 7.5% in FY26. The Economic Survey projects FY27’s GDP in the 6.8-7.2% range. While these numbers can vary on a host of factors (including the impending release of a GDP series with a new base year), the consensus is that the underlying growth momentum remains reasonably supported. The next push to growth needs to come from the ease and speed of doing business in India rather than relying on counter-cyclical measures like interest rate reductions (which has run its course). The Economic Survey has been also echoing the need to bring down the structural cost of capital in the economy.
The author is Head-India, Economics Research, Standard Chartered Bank