In an earlier column, “Why the RBI should reduce interest rates”, published on September 19, we had discussed why the stance of withdrawal of accommodation is outdated, and had called for changing the stance to neutral. We had also mentioned that in the context of the review meeting of the Monetary Policy Committee (MPC) on October 9, if not a rate reduction per se, it is high time for change of stance to neutral, in tune with the global scenario.
That did happen in October. In the MPC meeting, which was held between October 7 and 9, the central bank changed its stance from withdrawal of accommodation to neutral. To recap, that was the first meeting of the reconstituted MPC, where the earlier three external members retired and three new members were nominated by the government. The voting pattern for the interest rate pause decision in the October meeting was 5:1 with one external member voting for 25 basis points (bps) rate cut. Voting for change of stance was unanimous among the six MPC members.
The way forward
The next meeting of the MPC is scheduled to be held between December 4 and 6, followed by another one between February 5-7. There is a strong case for initiation of the policy rate easing cycle; and the rationale is as follows:
Inflation is under control and within acceptable limits. In the first six months of the current financial year, 2024-25, consumer price index (CPI) inflation has averaged 4.57 per cent. In the previous year, 2023-24, inflation averaged 5.36 per cent. For the full year, 2024-25, RBI’s inflation projection is 4.50 per cent. This is a shade higher than the target of the RBI, which is 4 per cent.
For next year, 2025-26, RBI’s projection is 4.1 per cent. Hence, we are moving towards the goal of achieving 4 per cent CPI inflation. In September 2024, inflation was at 5.49 per cent. This was due to an unfavourable base effect as the inflation index in September 2023 was on the lower side. Inflation for October, which will be announced on November 12, is expected to be on the wrong side of 5 per cent due to the same reason, which is unfavourable base. December onwards, it is expected that we will resume the move towards the target of 4 per cent inflation.
GDP (gross domestic product) growth is buoyant, but easing at the margin. In 2023-24, GDP growth rate was 8.2 per cent. For the current year, 2024-25, RBI’s projection is 7.2 per cent, but the projection from the government is more conservative, in the range of 6.5 to 7 per cent. For next year, 2025-26, RBI’s projection is 7.1 per cent. There is a panel of professional forecasters set up by RBI, which has projected 6.7 per cent GDP growth for next year. Hence, while growth rate is positive, at the margin, it will be good to support it by lowering interest rates to a reasonable extent.
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Currency exchange level: For all the headlines that INR (Indian rupee) has hit all-time low, to put in perspective, the pace of depreciation of our currency has been moderate. From 83.32 on March 29 to 84.29 on November 7, it has depreciated 1.16 per cent. From 81.98 as in the end of March 2023, it has depreciated 2.82 percent. There is no pressing need to keep interest rates high to support the currency level; it is more about crossing the psychological level of 84. There have been phases of faster weakening of our currency.
Globally, central banks are easing interest rates. US Federal Reserve eased interest rate by 50 bps on September 18. On Thursday, the Fed cut by another 25 bps. European Central Bank (ECB) has cut rates thrice in the current easing cycle. Bank of England has cut rates twice, including a rate cut, on Thursday. Many economies such as Switzerland, Sweden, Canada, etc. have eased interest rates. China has been easing interest rates for a long time any which way. Though the RBI takes interest rate decisions as per our fundamental factors, global developments do influence the discussions of the MPC.
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Real positive interest rate: The parameter for the MPC is real positive interest rate. CPI inflation for 2024-25, as projected by the RBI, is 4.5 percent. Going by this parameter, repo rate being at 6.5 percent, there is 2 percentage point real positive interest rate, which is on the higher side for a growing economy. Next year, 2025-26, the projected inflation is 4.1 per cent, hence the real positive interest rate will be higher, but for any rate cut.
For the next MPC meeting in December, the issue is that inflation data for October would be on the higher side, implying two consecutive months of more than 5 percent inflation. Data for November will be announced on December 12. Hence, on February 7, 2025, you can look forward to resetting your floating rate loans lower.
The writer is an author and a corporate trainer (financial markets).
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