The RBI is expected to maintain its key policy rate in its upcoming monetary policy review, a decision driven by several critical domestic and global factors. Despite global trends pointing toward rate cuts, and improvements in the domestic economic environment such as a better monsoon and softer credit growth, the RBI’s six-member monetary policy committee, led by Governor Shaktikanta Das, appears set to adopt a cautious approach.
At the center of the RBI’s decision-making is inflation, particularly within the food sector. Economists believe that the RBI is likely to prioritize a sustained reduction in inflation before considering any adjustments to the repo rate, which currently stands at 6.50%.
This cautious stance aligns with the RBI’s ongoing policy of “withdrawal of accommodation,” a position it has maintained even as other central banks like the European Central Bank (ECB) and Bank of England (BoE) have begun easing their rates. The US Federal Reserve is also expected to cut rates later this year.
In the June policy review, two members of the monetary policy committee had argued in favor of a rate cut, citing weakening growth indicators and the potential benefits of a lower real interest rate. However, this view did not gain majority support, and it remains uncertain whether the argument will gain traction in the upcoming meeting. Economists suggest that the RBI may be reluctant to shift its stance until there is more concrete evidence of a durable reduction in inflation, especially in light of the global economic uncertainty and its potential impact on India’s growth prospects.
One significant factor contributing to the RBI’s cautious approach is the current state of liquidity in the banking system. Banking sector liquidity has eased, with a surplus of approximately Rs 2.6 lakh crore, leading to a decline in overnight rates, which are now trending below the repo rate.
This has been partly due to the government’s ramped-up spending, which is expected to further ease liquidity conditions in the coming months. To manage this excess liquidity, the RBI has been conducting Open Market Operation (OMO) sales, a move that signals its intent to keep a tight grip on monetary policy until inflation is firmly under control.
The stock market, meanwhile, is closely watching for any changes in the RBI’s policy stance. A shift to a “neutral” stance from the current “withdrawal of accommodation” could signal a potential rate cut trajectory in the future, which would be a significant development for investors.
However, economists like Pranjul Bhandari, Chief Economist for India and Indonesia at HSBC Global Research, argue that such a shift would be premature given the current economic conditions. Bhandari notes that while the monsoon has improved, it is still too early to confidently predict a sustained decline in food prices, and the RBI may prefer to wait another month to assess the full impact of the monsoon on agricultural output.
Globally, markets are also facing increased volatility, driven by evolving macroeconomic conditions and geopolitical uncertainties. The recent hike by the Bank of Japan (BoJ) has led to a ripple effect across global markets, adding to the uncertainty.
Economists at Emkay Global warn that this volatility is likely to persist through the second half of 2024, influencing the RBI’s decision-making process. They note that global commodities, including Brent crude, have softened in recent weeks, which could have a significant impact on inflation and, by extension, the RBI’s policy stance.
Mahendra Kumar Jajoo, Chief Investment Officer – Fixed Income at Mirae Asset Investment Managers, expects the RBI to maintain its current stance, despite growing expectations for rate cuts following signals from the US Federal Reserve.
Jajoo points out that while a rate cut could boost returns for mutual funds, the slow growth of bank deposits relative to credit and the unattractive rates on longer-term deposits suggest that there is little room for the RBI to lower rates significantly in the near term.
As the RBI prepares to announce its decision, the markets will be looking for any clues about the future trajectory of interest rates. For now, it appears that the central bank is content to wait and watch, prioritizing stability and caution in an increasingly uncertain global economic environment.
