Aastha Gudwani, India Chief Economist, Barclays
Even as the RBI MPC delivered a widely expected ‘pause’ today, fixed income markets sold off. The MPC voted unanimously to keep the policy repo rate unchanged at 5.5 percent and to retain a ‘neutral’ stance. Markets seem to have priced today’s move as the end of the easing cycle, but we beg to differ. We believe there is policy room to deliver another cut in October, taking the terminal rate to 5.25 percent given the RBI revised down its CPI inflation forecast for FY25-26 by 60 basis points (bps) to 3.1 percent year-on-year. Of course, the question then is, if the RBI could cut, why would it not cut today, especially as we sit at the brink of the upcoming festive season.
We believe there are three factors that guided today’s calibrated pause by the MPC. Firstly, the front-loaded cuts in a short span of time are still working their way into the real economy with transmission well underway and that demands continuous watch. Of the 100 bps policy repo rate cut since February, retail lending rates are down between 30 and 100 bps. While the EBLR (External Benchmarks Lending Rate) is naturally down 100 bps (as of March 2025, 61.6 percent of the loan book is linked to EBLR), 1-year MCLR (Marginal Cost of Funds based Lending Rate) fell by 30 bps over the same period (February-June). WALR (Weighted average lending rate) on fresh loans and on outstanding loans fell by 71 bps and 40 bps, respectively. Transmission to retail deposit rates has been mixed, with WADTDR (Weighted average term deposit rate) on fresh and fixed deposits down by 87 bps and 9 bps, respectively. Amid still surplus liquidity conditions and front-loaded monetary easing, we think transmission is working its way into the real economy quite well.
Second is the tariff overhang and has created ongoing uncertainty. With trade negotiations still underway, assessing any growth-inflation impact right away is quite difficult. The RBI MPC had revised down its GDP growth estimate in February by 20 bps to 6.5 percent year-on-year, partly reflecting tariff-related risks, but uncertainty has accelerated since then. Of the 18 high frequency economic activity indicators we track, only seven indicators saw quarterly growth rates in Q1 FY25-26 on average higher than Q4 FY24-25. Overall economic activity seems to have moderated in Q1 FY25-26 already and tariff uncertainty is expected to continue to weigh in coming quarters.
Third, the sharp downward revision of the inflation forecast was squarely due to lower food inflation, discounting which, core CPI has been rather steady at 4 percent. Food prices are known to be volatile and one can look through such inflation moderation on these transient reasons. The RBI considers both core and CPI inflation as important.
We think these factors made a strong case for a patient watch, and as such explain the RBI’s decision to pause today. We found the statement quite neutral, with an emphasis on data dependence. With the sharp downward revision of its CPI inflation estimate, we believe the RBI MPC has maxed out scope for any more surprises. However, on growth, we expect the incoming data to fall short of the RBI's 'resilience' expectation. Accordingly, we expect the RBI MPC to deliver a final cut of 25 bps in October, the window for another cut is quite small, and if the RBI MPC does not cut in October, a cut in December could become challenging, in our view.
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