Inflation plays spoilsport…rate cut delayed

The RBI MPC continued to maintain a status quo on repo rate for the 11th time at 6.5% (by 4:2 majority), as retail inflation surged to 6.21% in October, surpassing the RBI’s target range for the first time in a year. The MPC also decided to continue with the neutral monetary policy stance and to remain unambiguously focused on a durable alignment of inflation with the target.

The Governor flagged rising risks, including weather disruptions, financial volatility, and geopolitical tensions, as factors that could push inflation higher. Growth in real GDP in Q2 at 5.4 per cent turned out to be much lower than anticipated. Consequently, FY25 forecast was revised down from 7.2% to 6.6% and Q1FY26 from 7.3% to 6.9%.

Retail inflation expectations inched up to 4.8% for FY25 from 4.5% earlier. Going forward, as food price shocks wane, headline inflation is likely to ease and realign with the target. Headline inflation for Q2FY26 is expected to be at comfortable levels of 4%. Adverse weather events and rise in international agricultural commodity prices, however, pose upside risks to food inflation. Heightened geo-political uncertainties and financial market volatility add further upside risks. The central bank emphasized the need to closely monitor evolving risks, particularly as high inflation could weigh on GDP growth.

Even as liquidity in the banking system remains adequate, systemic liquidity may tighten in the coming months due to tax outflows, increase in currency in circulation and volatility in capital flows. To ease the potential liquidity stress, RBI announced a CRR cut of 50 bps, the first since March 2020, to be cut in two tranches of 25 bps each - both in Dec 2024. This reduction in the CRR would release primary liquidity of about ₹1.16 lakh crore to the banking system. Given the focus on inflation control, this measure may prolong the process of bringing inflation under control unless the fresh agri crop arrivals result in a sharp fall in food and edible oil prices or growth continues to remain sluggish.

Net FPI inflows to India stood at US$ 9.3 billion in 2024-25 so far (April-December 4), supported mainly by inflows in the debt segment. To attract more capital inflows, RBI has permitted banks to raise fresh FCNR(B) deposits of 1-3 years maturity at Alternative Reference Rate (ARR) plus 400 bps (250 bps currently) and 3-5 years maturity at ARR + 500 bps (350 bps) till March 31, 2025.

High frequency indicators available so far suggest that the slowdown in domestic economic activity bottomed out in Q2FY25, and has since recovered. Agricultural growth is supported by healthy kharif crop production, higher reservoir levels and better rabi sowing. Industrial activity is expected to normalise and recover from the lows of the previous quarter. The supply chain pressures eased in October-November and fell below the historical average. On the demand side rural demand is trending upwards, government consumption is improving and investment activity is also expected to improve.

The 10-year G-Sec yield rose 3bps to ~6.77% post the announcement of the policy after having fallen in anticipation of CRR cut a couple of days back. Equity markets got what they wanted and hence have taken the policy outcome in their stride. Near term moves in the markets could remain dependent on foreign flows till the time the Indian macros and micros show sustained improvement.

The RBI is traversing through a difficult period with rising inflation and moderating growth. It has adopted a prudent and cautious approach to wait for better visibility on the growth and inflation outlook before beginning the rate easing cycle. Although the RBI governor remained positive on the inflation and growth dynamics, the upward revision in CPI for FY25 has diluted the chances of a rate cut in Feb’25.