Since February 2023, India’s Monetary Policy Committee (MPC) has seen little need to tinker with the policy rates. Rarely does it happen that a Central Bank can strike such a fine balance between ‘progress towards target inflation’ and ‘healthy economic growth’ for an extended period of time. For that, we must appreciate the admirable job done by our policymakers. But the status quo ends soon. A series of gradual developments, both local and global, lead us to believe that the monetary policy is about to be set in motion and we expect the MPC to signal this impending change in October.
The first development shaping our view is the outlook on food price inflation. Volatile food prices and their subsequent impact on generalised inflation have been a concern for the MPC. However, the rain gods have been kind this season. Good rains and healthy reservoir levels are expected to help keep food inflation under check, at least until the next monsoon. That’s one less thing for the Reserve Bank of India (RBI) to worry about. Additionally, Brent crude price has seen a meaningful decline this year from ~90 USD/bbl to almost 70 USD/bbl. On the other hand, core Inflation in India continues to remain well-behaved. Together, these developments have tilted the balance in favour of a durable fall in inflation closer to the MPC’s target.
Another major development has been the onset of rate cuts in major developed economies in general, and the United States in particular. While policy rate cuts in Eurozone and the United Kingdom were along expected lines, the US Federal Reserve surprised markets with an outsised 50bp cut in Fed Funds Rate. It may be worth noting here that this faster pace of easing is not yet taken as a hint of deeper rate cuts by the markets. This is because these rate cuts are seen as normalisation of policy rates from current very high levels and not as easing in response to a sharp economic downturn. Nevertheless, a 50 bps rate cut by the US Fed is difficult to overlook, no matter its colour. In fact, this sharper-than-expected rate action by the Fed has given other Central Banks a window of opportunity to normalise their high policy rates without having to worry about the devaluation of their currencies. In such an environment, India will feel more comfortable walking the path towards neutral policy rates, albeit with no haste.
Why no haste? For starters, the room for rate cuts in India may be far less compared to the US and other major economies. Our economic engine is firing on all cylinders and is in little need of immediate policy support. Secondly, bond prices in India have rallied during the course of this FY owing to favourable supply-demand dynamics. Rising bond prices i.e. falling bond yields mean that markets have already done some of the MPC’s work by lowering the cost of borrowing. Odds are that favourable demand-supply conditions will persist even into 2H FY25, keeping the financial conditions easier to that extent. Finally, much of the MPC, this time around, will be a fresh pair of eyes and they may want to take a little time to weigh a proportionate response.
There is one thing that the MPC can do in the upcoming October policy. The MPC can change its policy stance from “withdrawal of accommodation” to “neutral”. Upside risks to inflation have broadly abated, thereby suggesting a neutral policy environment. One can always argue that more ground needs to be covered to get to the last mile of disinflation, yet moving past a restrictive policy stance is merely the first step. Such a change in stance may be accompanied by moderately hawkish rhetoric to underscore the importance of durably low inflation. Even with a neutral stance, the MPC retains the flexibility to respond either way depending on the situation. On balance, a change in stance is a more likely outcome than a rate action in October. Irrespective of the outcome of this policy, bond markets may treat every monetary policy beginning December 24, as potentially, a live policy. Rate actions in the future may be closer than they appear.
The author is Executive Vice President & Debt Fund Manager at Kotak Mahindra Life Insurance Company.
