US has cut rates, inflation in India is below 4%, so why hasn’t RBI cut interest rates for 20 months now?

Why did MPC keep Repo rate unchanged?

The RBI’s policy panel kept the Repo rate steady in a 5:1 majority decision. New MPC Member Nagesh Kumar, Director and Chief Executive, Institute for Studies in Industrial Development, voted to reduce the Repo rate by 25 basis points.

RBI Governor Shaktikanta Das said for September inflation is expected to experience a significant jump due to unfavourable base effects and rising food prices. The headline inflation trajectory would sequentially moderate in the fourth quarter but he cautioned that unexpected weather events and geopolitical tensions continue to present major upside risks to inflation, Das said.

Analysts said the current circumstances are not really conducive for the RBI to opt for any affirmation action towards an easier monetary policy. “While the fear of the inflation “elephant” may have subsided with the CPI headline print well within 4.0% over the last two months and a favourable monsoon, the concerns around the stability of food inflation still linger among policy makers,” said Suman Chowdhury, Executive Director & Chief Economist, Acuité Ratings & Research.

There has been a sudden escalation of the chronic geo-political conflict in West Asia with a direct confrontation between Israel and Iran which has the potential to spike global oil prices and raise the uncertainty around the inflation outlook. To make matters further complicated, the latest economic indicators don’t look encouraging. PMI indices are at a multi-month low in September 2024 and the core sector output has seen a contraction after 42 months.

The risk on food inflation is not yet abated with daily retail prices indicating a rise in vegetable prices. September CPI (consumer price index) inflation print is estimated at 5.2 per cent versus 3.7 per cent in August. Majority of the rise is due to less supportive base-effects. On a month-on-month basis, the estimate builds-in a rise in food prices. The near-term headline CPI inflation trajectory is tracking at near 5 per cent in Q3 FY25, said Gaura Sen Gupta, Chief Economist, IDFC FIRST Bank.

While there were hopes for a rate cut in line with the US Fed, the RBI has taken a prudent approach by focusing on key indicators like domestic inflation and financial stability, particularly in light of the declining individual savings as a percentage of GDP, which poses a financial stability risk, analysts said.

Why monetary policy stance was changed?

The RBI decision to change the policy stance from withdrawal of accommodation means it won’t initiate measures to reduce money supply in the system. The regulator was following the withdrawal of accommodation stance since June 2022 to bring down inflation while supporting the growth.

However, the MPC said the policy stance will remain “unambiguously focused on a durable alignment of inflation with the target” while supporting growth.

The RBI’s shift to a ‘neutral’ stance marks a pivotal step in its approach, providing more flexibility in navigating the evolving economic conditions. “With food inflation easing and the monsoon being favourable, this change signals optimism for India’s inflation outlook. Globally, trends such as the US Federal Reserve’s rate cut and easing monetary policies further support this shift. By adopting a more neutral position, the RBI is positioning itself to respond dynamically to future developments, while continuing to foster economic stability and long-term business confidence,” said Anu Aggarwal, Head of Corporate Banking, Kotak Mahindra Bank

“The latest near-term macro data remains mixed, and early signs of slowdown are on the horizon. Also, inflation is nearing its target on a four-quarter rolling basis, the closest it has been in 22 quarters,” said Dhiraj Relli, MD & CEO, HDFC Securities. This might have to the shift in stance to neutral. The shift makes senses if the RBI wants to entertain the idea of a rate cut later in the year, analysts said.

Why did MPC keep inflation, GDP projections unchanged?

The policy panel has kept the retail inflation and GDP growth forecasts unchanged at 4.5 per cent and 7.2 per cent respectively for fiscal 2024-25.

RBI Governor said inflation print for the month of September is expected to see a big jump due to unfavourable base effects and pick up in food price momentum, caused by the lingering effects of a shortfall in the production of onion, potato and chana dal (gram) in 2023-24, among other factors. The headline inflation trajectory, however, is projected to sequentially moderate in Q4 of this year due to good kharif harvest, ample buffer stocks of cereals and a likely good crop in the ensuing rabi season.

Unexpected weather events and worsening of geopolitical conflicts constitute major upside risks to inflation. International crude oil prices have become volatile in October. The recent uptick in food and metal prices, as seen in the Food and Agricultural Organisation (FAO) and the World Bank price indices for September, if sustained, can add to the upside risks, Das said.

India, as of now, doesn’t face the challenge of the GDP growth falling consistently. The low GDP growth numbers of 6.7% in Q1 were primarily driven by adverse base effect and a slowdown in government-driven investment expenditures due to general elections in Q1, according to Ajit Banerjee President & Chief Investment Officer, Shriram Life Insurance Company.  This was the main driving force behind the GDP growth of the country. “Much to our relief, the government capex has resumed in Q2, and therefore, GDP growth numbers would fall in line with RBI projections,” he said.

India’s retail inflation rate was 3.65 per cent in August 2024, higher from 3.54 per cent in July 2024.

What will happen to lending rates?

As the RBI has left the Repo rate steady at 6.5 per cent, all external benchmark lending rates (EBLR) linked to the repo rate will not increase, giving relief to borrowers as their equated monthly instalments (EMIs) will not increase.

However, lenders may raise interest rates on loans that are linked to the marginal cost of fund-based lending rate (MCLR), where the full transmission of a 250-bps hike in the repo rate between May 2022 and February 2023 has not happened.

In response to the 250-bps hike in the policy repo rate since May 2022, banks have revised upwards their repo-linked external benchmark-based lending rates (EBLRs) by a similar magnitude. The one-year median MCLR of banks has increased by 170 bps during May 2022 to August 2024.

When is RBI expected to cut repo rate?

There are expectations that the RBI will deliver the first Repo rate cut in December 2024. “If food inflation moderates, we could see a shallow rate cut of 50 bps in the upcoming policy meetings in this fiscal year. the MPC will be cautious regarding the evolving risks to food inflation. Although core inflation has remained relatively benign, higher food inflation has kept the headline numbers elevated,” CareEdge Ratings said.

HSBC sees Repo rate cuts of 25 bps each in the December and February meetings, taking the repo rate to 6 per cent. “Slowing growth and falling inflation offer room for the RBI to cut rates in coming months. We expect repo rate cuts of 100 bps by December 2025, beginning December 2024,” Bank of America said.