MPC balances prudence and practicality amid divergent growth inflation dynamics

Two largely anticipated changes were the revisions in the MPC’s quarterly and annual CPI and GDP forecasts.

After the October 2024 policy review, the Monetary Policy Committee (MPC) was faced with a barrage of increasingly unpleasant data. Firstly, CPI inflation surged to 5.5% in September 2024 and further to 6.2% in October 2024. Soon after that, the GDP growth print for Q2 FY2025 revealed a disconcerting dip to 5.4%.

As expected, the optics of CPI inflation exceeding the upper threshold of the MPC’s medium-term target range of 2-6% made it imprudent for the Committee to cut the repo rate in its December 2024 policy review, despite the slowdown in India’s GDP growth. At the same time, in a practical decision to support economic activity, the Reserve Bank of India (RBI) announced that the cash reserve ratio (CRR) would be reduced by 50 bps in two tranches in December 2024, to infuse durable liquidity of Rs 1.16 lakh crore.

Two largely anticipated changes were the revisions in the MPC’s quarterly and annual CPI and GDP forecasts. In line with our own projection, the Committee raised its CPI forecast for FY2025 to 4.8% in the December 2024 policy meeting, up from the previous 4.5%. Importantly, it envisions CPI inflation at 4.0% in Q2 FY2026, the elusive midpoint of its medium-term target.

Further, the MPC reduced its FY2025 growth forecast to 6.6% from 7.2%, following the large miss in Q2 (5.4% versus the MPC’s October 2024 forecast of 7.0%). We believe that India’s GDP is likely to expand by around 6.5% in both FY2025 and FY2026, in the current global context, and that its potential growth is closer to 6.5-7.0%, not the aspirational 7.0-8.0% suggested by some.

With transient issues easing, particularly the dousing of sectors like mining and electricity by the above-normal monsoons, we expect back-ended government capex and a sustained improvement in rural sentiment to boost GDP growth in H2 FY2025. Additionally, we forecast headline CPI inflation at 5.5% in November 2024 and around 5.0% in December 2024. If no new risks emerge that derail the moderation in inflation to the projected 4.0% by Q2 FY2026, a repo rate cut in February 2025 could very well be on the table.

Interestingly, the MPC’s decision to pause in December 2024 was not unanimous, with two external members voting for a 25 bps rate cut. The minutes, which will be published in a fortnight, are usually carefully analysed to glean insights into the members’ likely future voting patterns, although the composition of the MPC may well change in the immediate term.

The December 2024 MPC meeting was the last scheduled review for this calendar year. We do not yet know if it will prove to be the last in other respects, including the ultimate one before the timing becomes appropriate to embark on rate cuts. Notwithstanding the arguably heightened global uncertainties, we maintain our baseline view that domestic inflation and growth dynamics support a shallow rate cut cycle of 50 bps, which could be spread over the February 2025 and April 2025 policy meetings.

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