Quick Take | As RBI changes stance to 'neutral', countdown begins for a rate cut in Dec

RBI retained the key interest rates for the 10th consecutive policy meeting.

It was the tenth time in a row that the Monetary Policy Committee (MPC) of the Reserve Bank of India chose not to tweak the key interest rate.

But that was not a surprise, to be true.

The key takeaway this time was the change in the monetary policy stance to 'neutral' from 'withdrawal of accommodation'. This is a clear signal from the RBI that a rate cut is round the corner if inflation continues to stick to the easing path.

Look closer. Governor Shaktikanta Das typically chose his words. "The inflation horse has been brought to stable with great difficulty." But he was quick to add that caution is warranted to keep it under control.

This offers a hint of the thinking within the central bank on its fight against inflation. Clearly, there is a sense in the RBI brass that a big part of the fight is over. In other words, the stage is set for the start of a rate-cut cycle.

The MPC has time and again spelt out its one single condition to kick-start the rate cut cycle — aligning the retail inflation around the 4 percent target in a sustainable manner.

Have we reached there? Indeed, the retail inflation shows the early signs of easing to that target level but it is not strong enough yet. The MPC would love to watch a little more to see how it grows.

At this point, there are three key upside risks to inflation.

First and the most significant is the volatility in food inflation. Food group weighs around 46 percent in the CPI inflation basket. As this Chart of the Day piece explains, there is an unshakable link between vegetable prices and food inflation. High vegetable prices have kept the food prices on the boil. This is beyond the control of the rate-setting panel. A clutch of factors, including supply chain functioning, crop production, and rain distribution are crucial here.

The second is the fresh geopolitical risks emerging out of the Iran-Israel tussle. If the war spreads across a wider Middle-Eastern territory, it would drive up crude prices. India cannot escape the blaze as imports make up more than 8 percent of its crude oil demand. In a cascading effect, prices of everything will shoot up soon.

The third factor is a likely resurgence in core inflation. The non-volatile part of inflation has stayed well below 4 percent since January 2023, according to Bloomberg data, but it may start moving north with the global commodity prices on the rise.

This is probably an outcome of companies holding back their price increases in an already high inflation scenario. But those price hikes can happen now - in fact, it’s happening with tariff hikes across industries - which will trigger the core CPI inflation to go up.

In a recent note, DBS Bank economist Radhika Rao said the core CPI inflation is expected to tick up on telecom tariff and gold prices but undershoot the headline CPI inflation pointing to modest pricing power. One needs to see how this scenario pans out.

The hard fact is that the MPC cannot ignore growth for too long. It has been highlighted by even MPC members in the past that the economy is growing well below its potential and real interest rates are higher than where it should be. On the ground, the employment scenario doesn't look too good.

Also, the RBI is now increasingly under pressure to rethink on rates after the more-than-expected 50-bps rate cut by the US Federal reserve. Typically, the RBI follows the cues from the Fed.

Then, what next?

Before the December meeting, there will be two rounds of inflation prints — September and October. September may see a higher inflation number, but this will be largely due to a lower base effect. If inflation sticks to Das’s script and doesn't throw up a surprise on the upside beyond the base effect, one could see the first rate cut in December.

The countdown has begun.