Globally, the balance of risk between growth and inflation has decidedly shifted towards downside risk to growth. The US Federal Reserve delivered a larger-than-expected cut of 50 basis points (bps) in its effort to not be behind the curve. Other central banks, which had initiated rate cuts before the Fed, are taking a more gradual approach of 25 bps cut every other meeting.
Against this backdrop, the Reserve Bank of India's October policy will be watched for clues on future turn in the policy.
The reason why we still expect the RBI to maintain the status quo next week is because the growth-inflation risks have not yet dramatically turned.
Unlike developed markets (DMs), which are grappling with a growth slowdown, in India, growth remains on the stronger side. The Q1FY25 GDP print of 6.7 percent was softer than 7.8 percent in Q4FY24 but the internals were much better.
Private consumption picked up in Q1FY25 after a lacklustre FY24, likely reflecting improvement in rural demand and urban holding-up. Investment (or Gross Fixed Capital Formation) was also tracking higher in the quarter despite lesser support from General Government expenditure. There was a sharp decline in both Centre and state government capital expenditure due to the general elections.
The RBI’s assessment on growth remains positive with its Q2 GDP estimate tracking at 7 percent. It is likely to retain its FY25 GDP growth estimate at 7.2 percent.
After the election, there has been a sharp pick-up in government expenditure (both Centre and state governments). This is reflected by a decline in government cash surplus from peak levels of Rs 5.1 lakh crore as of May 24 to Rs 2.1 lakh crore surplus as of September 13. Hence, government support to the capex cycle and services sector is expected to pick up in the remainder of FY25.
While we expect growth to remain strong in FY25, there are signs of moderation in consumption demand in Q2.
High-frequency indicators are mixed, with a slowdown in passenger vehicle sales, two-wheeler sales and consumer goods production. Non-oil, non-gold imports growth, which is a key indicator for domestic demand, has remained moderate in FYTD25 (Apr-Aug) at 3.9 percent on-year in nominal terms.
Rural demand is expected to improve as monsoon has been relatively distributed better this season than the previous year. That said, rural wage growth remains weak at 5.3 percent in FYTD25 (April-July) in nominal terms. Urban demand is expected to moderate with urban wage growth slowing since H2FY24.
No rush for a cut
Given the positive assessment of growth, the RBI is not expected to be in a hurry to cut policy rates.
The inflation outlook has improved with some moderation in food inflation pressures. Overall headline inflation on a year-on-year has remained below 4 percent in July and August. This was primarily due to the supportive base effect, which pulled down year-on-year inflation. Some decline was also seen in food inflation pressures in August as supplies improved. On a month-on-month basis (non-seasonally adjusted), food prices were lower by 0.3 percent in August.
However, this may not be enough to give the RBI confidence to ease policy rates next week.
Food inflation risks persist with retail vegetable prices tracking higher in September (Source: National Horticulture Board). Other food items such as pulses and cereals, which have shown more persistent inflation pressures, continued to ease in September, albeit at a more moderate pace.
The near-term inflation trajectory looks less favourable, with Q3FY25 headline inflation averaging at around 5 percent, as support from base-effect wanes.
Relatively strong growth conditions provide policy space to wait for further clarity on food inflation. Hence, the RBI is expected to maintain the status quo on interest rates in the October policy.
December cut on cards?
The rate-cut cycle is expected to begin in December. By then, the central bank will have two more months of inflation data (October and November) to assess the durability of the disinflation process.
Overall monsoon performance has been even, with the majority of the country receiving normal rain. Kharif area under sowing has been higher than the previous year. Rabi crop outlook is positive with reservoir levels tracking higher than the 10-year average. Hence, we do expect food inflation to ease in the coming months, providing policy space to cut interest rates.
Despite the expectation of a December rate cut, we don’t expect the stance to be changed in the October policy.
The RBI has consistently indicated its preference to retain policy flexibility by not giving forward guidance. The change in stance has been linked to future policy rate path and delinked from liquidity conditions. Hence, the stance of withdrawal of accommodation is expected to be retained.
The key change would be a more positive assessment of the inflation outlook. This has already been seen in the latest RBI monthly bulletin (State of the Economy Chapter), which said “the persistence that characterised food inflation developments in the Q1FY25 may be behind us”.
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