A pivot in monetary policy in October is likely

Meanwhile, strong domestic growth provided the MPC some room to keep the interest rate on the higher side.

A new MPC

A new set of members generates curiosity on the likely voting outcome. The market is also looking forward to the new committee’s perspectives on the inflation, growth and liquidity scenario.

Since the June policy, two out of four members have voted in favour of a rate cut (by 25 basis points) as well as change in the stance (to neutral) – a change from one vote advocating a rate cut and change in stance. So, curiosity about the outcome of the voting pattern will be rife.

The MPC – as mandated legislatively – has seen a churn in its members ahead of the policy meeting this month. A turn, or a solid sign of an impending turn, in policy orientation could, coincide with the formation of a new team or members of the MPC. That not being the prime reason, there are others which suggest a turn could be in the offing.

Factors creating space for easing

So, what has changed on the macro front? Three things deserve attention.

Inflation has dropped below 4 percent in July and August. It is known that the fall in inflation from 4.9 percent in the June quarter, to below 3.7 percent average in July and August, is on account of the high base of last year. Inflation will climb up September onwards as the base benefit fades. But a good monsoon, healthy kharif sowing and improved prospects of the rabi, is expected to keep the lid on food prices.

Meanwhile, non-food inflation remains low. This should bring down the headline inflation this fiscal compared to the last and create room for monetary policy to ease.

In a scenario where non-food inflation rises slightly (say 50-bps) from levels seen in the first half, to get to the MPC’s forecast of 4.5 percent headline CPI inflation this fiscal, food inflation for the rest of the fiscal, can climb up from current levels (of ~5.6 percent) but will need to settle around 7 percent. This, at the moment, looks possible, though geopolitical conflicts that lead to input costs flaring up, the recent uptick in global food prices and adverse weather shocks, which have become more frequent, will remain risks.

Second, the big one – US Federal Reserve - has moved and the long-awaited synchronised policy rate easing cycle in advanced economies has begun. The US Federal Reserve’s large rate cut in September paves the way for a slew of central banks to follow suit, especially in emerging markets.

S&P Global expects the Fed policy rate to reach 3-3.25 percent by the end of 2025 and the European Central Bank rate at 2.5 percent by the third quarter of 2025. This means there could be another 175 bps rate cuts by the Fed and 100 bps cut by the ECB, till they reach their terminal rates. Inflation in these countries is gradually heading towards the target, but it is weaker growth that now invites attention from the central banks.

An easier monetary policy by advanced economies and in large parts of Asia creates space for rate cuts in India.

Third, the response to monetary tightening in the economy is playing out in some segments with signs of weakening growth, especially from urban areas, becoming evident. Credit growth has slowed to 13 percent as of mid-September from ~15 percent at the start of the fiscal, reflecting the impact higher interest rates and tighter lending norms.

While the RBI would like to support demand by lowering rates, in its recent communications, it has also voiced concerns on “funds being deployed to unproductive segments or for speculative purposes”. Recent data shows loans against gold grew 40 percent on year as of mid-August. With system liquidity back in surplus, this aspect is concerning. Hence a cut in rates, when it comes, could be accompanied by a stronger vigil on credit disbursements.

Other risks that could negatively impact inflation, growth and the currency include the outcome of the US Presidential election later this year and its impact on trade and escalating tensions in West Asia, which are disrupting shipping movements, transit costs and commodity and oil prices. Domestic risks to inflation largely centre on the impact of adverse weather shocks, if any.

Against this backdrop, CRISIL expects a change in stance in the October meeting to “neutral” from “withdrawal of accommodation” and a rate cut in the December policy. We expect rates to come down by a cumulative 50-bps this fiscal. This rate cut cycle is expected to be gradual, with greater reliance on liquidity management to ensure policy transmission.