RBI holds repo rates at 6.5%; cuts CRR by 50 bps

6 Dec 2024 , 07:57 PM

WHAT CHANGED SINCE THE OCTOBER 2024 MONETARY POLICY

Before we get into the nuances of the policy announcement, here is a quick look at how the macro scenario changed between the October and the December policy statements. On the one hand, the inflation rate has spiked to 6.21% in October, which had already ruled out any rate cut in the December policy. Also, there is visible pressure on the current account as the trade deficit has been well above $20 billion in the last 6 months. The CAD for Q2FY25 will be only announced in the last week of December, but early estimates already peg the CAD at 1.6% of GDP. But the real shocker came from the GDP growth figure for Q2FY25, which plummeted to 5.4%, nearly 100-125 basis points below street expectations. These led to the RBI cutting its growth estimates for FY25 and raising its inflation estimates.

The other X-factor is more global in nature. While the Federal Reserve has already cut interest rates by 75 bps since September, the RBI has not move an inch. Now, one can only expect the first rate cut to happen in February 2025 as the central bank has held status quo on rates and on the monetary stance in the December 2024 policy also. The oil prices have been subdued around $71.50/bbl in the Brent market and with the OPEC delaying output hikes, oil prices should be stable. However, the bigger concern is the Indian rupee, which has weakened to ₹84.7/$ and is now pegged to get closer to $86/$ by next year. It is in this background that the December 2024 monetary policy was announced by the RBI.

CAN THE 50 BPS CRR CUT MAKE A DIFFERENCE?

Amidst the rising inflation and the cautious statements by the RBI governor, it was already evident that rate cuts were ruled out in December. However, a 50 bps rate cut was widely expected. The RBI did cut CRR by 50 bps from  4.5% to 4.0% in two tranches effective from the middle of December. This CRR cut is likely to release around ₹1.16 Trillion of liquidity in the system. This is insufficient considering that nearly ₹3.70 Trillion of government spending has gone out of the ambit of commercial banks and is being directly handled by the RBI’s e-Kuber system. Hence this could be a signal that there may be more CRR cuts and eventually the CRR (cash reserve ratio) may settle at around 3.0%.

Will this make a difference to the rates in India. That is very unlikely and rates are likely to be impacted only if the repo rates are lowered. However, for the banks, this CRR cut would reduce the unproductive portion and would boost the NIMs by around 4 bps. This could further increase, if the CRR is eventually brought down to 3.0%. For now, the RBI has held status quo on repo rates at 6.5% and held the stance of the policy at neutral, focusing on durable alignment of inflation with target; while supporting growth. What is interesting is that while the decision on stance was unanimous, the rate decision was voted 4:2; with Dr Nagesh Kumar and Prof Ram Singh voting for a 25 bps rate cut.

HIGHLIGHTS OF RBI POLICY STATEMENT – DECEMBER 2024

The RBI maintained status quo on rates for the 11th successive MPC meet. The previous RBI meet had shifted the stance to Neutral, which has been maintained in December too. Here are key takeaways from the MPC statement.

• RBI held repo rates at 6.50% for eleventh policy in succession. The last time repo rates were hiked was in February 2023. Dr Nagesh Kumar and Prof Ram Singh voted for a 25 bps rate cut. The decision to maintain stance of the policy at “Neutral” was unanimous.
• The RBI decided to cut the cash reserve ratio (CRR) from 4.5% of net demand and time liabilities (NDTL) to 4.0% of NDTL. This will be done in 2 tranches of 25 bps each. Experts believe, this could open the doors to another 100 bps CRR cut by the RBI.
• With the repo rates static at 6.50%, the linked rates also stayed put. The SDF (reverse repo) rate stays at 6.25% (25 bps below the repo), while the bank rate and the marginal standing facility (MSF) rate stay put at 6.75% (25 bps above the repo rate).
• The GDP estimate for FY25 has been cut sharply by 60 bps from 7.2% to 6.6% in line with the growth constraints faced by manufacturing and the weak Q2FY25 GDP number. This more than offsets the 20 bps upgrade to GDP estimates in the June policy statement.
• What about inflation forecast? The inflation forecast for FY25 has been upped by 30 bps from 4.5% to 4.8%. That is not surprising, considering the pressure on food prices and on manufactured products. The inflation for Q3 and Q4 have been sharply hiked.
• RBI continues to remain non-committal on the timing and quantum of rate cuts in the coming months; although markets are expecting a cut in February 2025. That may not happen if inflation sobers in November and GDP growth picks up in Q3FY25.

The one risk that the RBI does run is whether its unwilling ness to cut rates could create the risk of monetary divergence with the Fed. We have to wait till February 2025, for now!

RBI HIKES INFLATION PEG FOR FY25 TO 4.8%

For FY25, the RBI has hiked its inflation estimate by 30 bps from 4.5% to 4.8%; largely alone expected lines. With consumer inflation already at 6.21%, the 4.5% estimate for FY25 was almost unrealistic. While oil inflation has not been much of a challenge in recent months, most of the pressure is coming from food inflation and core inflation; with the latter taking a toll on profit margins of Indian corporates. For FY25, the inflation is expected to spike in Q3 and Q4 of FY25. While normalization of vegetable prices and Kharif arrivals in Mandis will help in Q4, part of the damage is already done. Hence, RBI has raised its inflation projection for FY25 by 30 bps to 4.8%. In terms of next four quarters; the RBI has projected inflation for Q3FY25 at 5.7%, Q4FY25 at 4.5%, Q1FY26 at 4.6%, and Q2FY26 at 4.0%. Bulk of the inflation pressure is seen in Q3 and Q4 of FY25.

RBI CUTS GDP GROWTH ESTIMATE TO 6.6% FOR FY25

With Q1FY25 GDP growth at 6.7% and Q2FY25 GDP plummeting to 5.4%, the cut in FY25 GDP estimates was almost a fait accompli. FY25 has witnessed a visible slowing of private consumption and a slowdown in investments. Hence, the RBI has cut the GDP estimates for FY25 by a full 60 bps from 7.2% to 6.6%. This is likely to trigger a slew of growth downgrades by other agencies and broking houses. RBI has cut the GDP growth estimates for FY25 by 6t0 bps to 6.6%. On a quarter-wise basis, the GDP growth is projected at: Q3FY25 at 6.8%, Q4FY25 at 7.2%, Q1FY26 at 6.9%, and Q2FY26 at 7.3%. The RBI is assuming deceleration in growth impulses in the third and fourth quarters of FY25 as well as in first quarter of FY26.

KEY POLICY SHIFTS ANNOUNCED BY RBI, OUTSIDE MPC AMBIT

RBI monetary policy went beyond monetary numbers to signal a shift at a policy level. Here are some key announcements.

• FCNR (B) rates of interest have been hiked in terms of higher spreads over the OARR. The spread has been raised from 250 bps to 400 bps for 1-3 year deposits and the spread has been raised from 350 bps to 500 bps for 3-5 year deposits.
• A committee has been appointed under Ramanathan Subramanian to review rupee interest rate benchmarks; especially the use of MIBOR. Based on the recommendations of the Committee, a benchmark on secured money markets will be introduced.
• The limit for collateral-free loans for agricultural currently stands at ₹1.60 lakhs for a borrower. This limit has been raised to ₹2.00 lakhs per borrower, which will allow for the integration of the small and marginal farmers into the formal credit system.
• Small Finance Banks (SFBs) will also be allowed to pre-sanctioned credit lines through the UPI platform. Currently, this facility can only be extended scheduled commercial banks. This is likely to bring about a more transparent credit culture.
• Finally, in a tech-savvy move, the RBI has set up a committed for ensuring ethical and responsible enablement of AI (artificial intelligence) in the financial sector. AI solutions are likely to be extensively used to identify mule accounts.

December 2024 monetary policy was action packed. While it held status quo on rates, it did cut the CRR, drop the growth estimate and raise the inflation estimate for FY25. The MPC is now more split on its rate view, and that is a good sign. We await sharper insights into the policy when the minutes are published on December 20, 2024; ahead of the next MPC meeting on February 05-07, 2024.