Exactly one week after Finance Minister Nirmala Sitharaman presented the interim budget for 2024-25, Reserve Bank of India (RBI) Governor Shaktikanta Das will announce the Monetary Policy Committee's (MPC) interest rate decision on February 8.
While there is unlikely to be anything substantially new from a monetary policy perspective, the finance ministry may have given Das and his fellow rate-setters some food for thought.
To be sure, no one really expects the RBI to actually lower the policy repo rate on February 8. In fact, it would be a huge surprise if even a single member of the MPC votes to cut interest rates this week. But an unexpectedly low fiscal deficit target of 5.1 percent of GDP for 2024-25 will not go unnoticed.
"From the RBI's vantage point, the fiscal policy will likely be seen as complementing the monetary policy," Nomura economists Sonal Varma and Aurodeep Nandi said.
"While the RBI's MPC is likely to keep the repo rate unchanged on February 8, we expect the first steps to address tight frictional liquidity and a more active discussion on removing the tightening bias in the policy guidance," they added.
Varma and Nandi see the first rate cut in August, with risks skewed towards the easing cycle beginning in June.
Liquidity has indeed become an issue. While linked to the stance of monetary policy, the banking system's liquidity has been in 'withdrawal of accommodation' mode for the better part of two years now and has seemingly been fully withdrawn considering the weighted average call rate is above the repo rate.
"…the infusion of durable liquidity is becoming necessary, and idealistically, the monetary policy stance should change to 'neutral' from 'withdrawal of accommodation' to maintain consistency of stance and action," Soumyajit Niyogi, a director at India Ratings and Research's Core Analytical Group, said.
Will the MPC then change its stance to neutral this week?
If one goes by the RBI's inflation forecast, there may or may not be a case. Sure, the MPC finally does have visibility when it comes to its inflation target, with the central bank's latest forecasts seeing Consumer Price Index (CPI) inflation hitting 4 percent in July-September, before rising to 4.7 percent in October-December.
But a sustained reduction in inflation is what matters. As external member Ashima Goyal has previously said, a sequence of forecasts showing a sub-5 percent headline retail inflation would present an opportunity to reduce interest rates.
Then there is core inflation. From as high as 6.1 percent in the first couple of months of 2023, retail inflation, excluding food and fuel items, had dropped dramatically to under 4 percent by the end of the calendar year.
According to Soumya Kanti Ghosh, State Bank of India's group chief economic adviser, a "behavioural shift" – demand shifting from offline to online – may explain why core CPI inflation has fallen so steeply.
"If this is sustained, the decline in core inflation could become more enduring in nature, opening up space for policy rate cuts," Ghosh said.
Like Nomura's Varma and Nandi, Ghosh thinks August is the "best bet" for the first rate cut from the MPC, although he sees the possibility of it coming in June, too.
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