With a rate cut unlikely due to high inflation, RBI may have to look at liquidity measures to lift GDP

RBI for sure needs to tame inflation. But, at the same time, it can't look away from the economic slowdown.

RBI Representational image | Reuters

To cut or not that will be the big question in front of the Reserve Bank of India's monetary policy committee when it meets between December 4 and 6 next week.

On one hand, there will be concerns over the sudden slowdown in the economy in recent months. Data released on Friday showed India's GDP growth slowed to a seven quarter low of 5.4 per cent in the July-September quarter. This is much lower than RBI's expectation of GDP growing 7 per cent in the second quarter. A slowing economy will typically warrant a cut in interest rate.

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However, the MPC will also be watchful of inflation and there is certainly no comfort there. The central bank has a CPI (consumer price index) inflation target of 4 per cent. Driven by high food prices, retail inflation in October jumped to a 14-month high of 6.21 per cent; it had been 5.49 per cent in September.

In the previous meeting in October, the MPC left repo rate unchanged at 6.5 per cent, but changed the stance to neutral.

The earlier expectation was the MPC would start cutting rates in December. But the high inflation print have dented those hopes and pushed the possibility of a rate cut to 2025 even as several major central banks, including US Federal Reserve, have decisively shifted to a rate easing cycle.

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Decision making is certainly becoming difficult for the RBI. It for sure needs to tame inflation. But, at the same time, it can't look away from the economic slowdown.

The global stage is set for more pronounced challenges next year, as the ripple effects of a global slowdown and potential disruptions from Donald Trump’s proposed tariffs play out against a backdrop of heightened geopolitical tensions.

"In the near term, financial markets are likely to remain volatile, making it imperative for India to maintain sufficient fiscal and monetary buffers to steer through the turbulence," note analysts at SBICaps.

While chances of a repo rate cut in December remain "remote," the RBI may move to ease liquidity for productive uses in the economy by cutting the cash reserve ratio (CRR), they feel. CRR is the percentage of cash that banks need to maintain in reserves against its total deposits.

There are two key reasons behind the economic slowdown. Consumption demand, particularly in urban areas, has been tepid. Several fast moving consumer goods companies raised concerns on that front post their September quarter earnings. Passenger vehicle sales too had been slowing before the festive season.

Government capital expenditure was also slow in the first half of the current financial year (April-September) in the wake of the parliamentary elections.

The latest GDP data also showed slow growth in construction and manufacturing.

Aditi Nayar, chief economist and head - research, outreach, ICRA, expects GDP growth to pick up in the second half of the financial year ending March 2025, as government capex is seen picking up, agriculture output is set to improve, in turn aiding rural consumption, resulting in a full-year expansion of 6.5-6.7 per cent.

ICRA's full year GDP expectation is significantly lower than the RBI's full-year GDP projection of 7.2 per cent.

"In light of the recent spike in the CPI inflation, we anticipate a status quo from the MPC next week. However, with the GDP growth print sharply undershooting the committee’s expectations, a February 2025 rate cut may be on the table if the next two inflation prints recede," said Nayar.

Nikhil Gupta, chief economist at Motilal Oswal Financial Services, is also not expecting any action from RBI next week, given the inflation. However, the probability has risen now, he said.

A rate cut in February 2025 is "very much live," he added, provided "inflation comes off."

Pramod Chowdhury, chief economist at DMI Finance, said the "sharper than expected" second quarter slowdown posed downside risks to its full year GDP forecast of 6.7 per cent.

"There is a need for a countercyclical policy response to address the slowing economic momentum," said Chowdhury.

He also expects government spending to improve in the second half, but still feels monetary policy flexibility "remains constrained" in the near-term due to elevated inflation.

Policy rate cut will have to wait for a significant moderation in inflation, expected by February 2025, he noted.

"In the interim, the RBI could consider supporting the economy in the near term through targeted interventions (to boost credit flow to specific sectors) and/or liquidity support," he said.

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