What to expect from October 2024 RBI Monetary Policy?

7 Oct 2024 , 09:34 AM

WILL THE US FED POLICY IMPACT THE RBI POLICY APPROACH?

The previous monetary policy in August was the first policy presented after the government formation and the presentation of the full budget on July 23, 2024. The August policy largely maintained status quo. Most of the members of the MPC had continued to be cautious about the inflation risks. However, two MPC members in the August policy; Jayanth Varma and Ashima Goyal had given a dissent vote, calling for a 25 bps rate cut as well as shifting the stance of the monetary policy to a neutral stance. Of course, the Monetary Policy Committee did not indulge in either of these demand and preferred a wait-and-watch approach. That was also the last policy meet for Goyal and Varma; with both having completed their 4 year terms. Hence, this MPC meeting in October 2024 will see 3 new members in the MPC with the remaining three being the RBI nominated members.

The MPC in October will see three former members of the MPC having demitted office on completion of their term. Prof Jayanth Varma of IIM-Ahmedabad, Prof Ashima Goyal of IGIDR and Dr Shashank Bhide of NCAER will not be part of the MPC any longer having completed their 4-year term as MPC members. Three new members have been inducted in their place. They include; Dr Ram Singh, Director, Delhi School of Economics; Dr Saugata Bhattacharya, former Chief Economist of Axis Bank, and Nagesh Kumar, Director and CEO, of the Institute for Studies in Industrial Development. Between the last MPC and the October MPC meet, the US Fed has embarked on an aggressive rate cut path. It has started off by cutting rates by 50 bps and has promised another 50 bps by the end of 2024 and an additional 100 bps by end of 2025, taking the Fed Funds rate to the range of (3.25% to 3.50%). How will that influence the MPC decision in October 2024?

The MPC  with 3 new members will surely find it a tough call to make. US Fed has not just cut rates by 50 bps, but has also guided for another 150 bps of rate cut by end of 2025. In the past, the argument was that the US rate is just 100 bps lower than the Indian benchmark rate. That was a valid argument. However, now the gap by end of 2025 would be 300 bps, and that is rather tough to justify. In the last few policy statements, the MPC members from the RBI have argued that there was no question of cutting rates when the inflation risks were still rampant. That is still true because while food inflation may be tempered by a record Kharif output this year, core inflation and fuel inflation could be a challenge for India. Also, there is the risk of monetary divergence from the world’s largest economy. That is not a very comfortable situation to be in. It is going to be a tough call.

WILL GEOPOLITICAL RISKS IMPACT THE RBI POLICY STANCE?

In fact, if there is one argument that the MPC may have at this juncture to not cut rates would be the worsening geopolitical situation. West Asia and the Middle East are vital to India’s oil supply and any worsening of the geopolitical situation could result in a spike in imported inflation. Any rate cut would pre-suppose that inflation would stay low. In the last 2 months, the consumer inflation has been consistently under the RBI average of 4%. However, if the geopolitical risks build up, then the impact on inflation could be quite meaningful. It is not just the impact of Israel bombing the oil installation of the National Iranian Oil Company (NIOC), but also the possibility that Iran could announce a blockade of the Straits of Hormuz, one of the key gateways to Asian trade. Any such move could spike oil prices making inflation in India extremely vulnerable.

To cut a long story short, if the aggressive dovishness of the US Fed has been urging the RBI to also embark on rate cuts, they now have the very legitimate excuse of the worsening geopolitical situation. RBI MPC can argue that in the light of the rising risks to imported inflation, they would prefer to hold status quo on rates. However, the problem is that the Fed is planning to cut rates by another 25 bps in November and an additional 25 bps in December. In that case, any status quo would be hard to explain in the December policy. However, that is still some time away and for now the focus is purely on what do in the October policy. The RBI MPC will use the uncertain geopolitical situation as a reason for not cutting rates at this juncture. However, the RBI may seriously  consider a rate cut in December. This will not only reduce the cost of funds, but also boost the valuation of assets.

HOW MACROS SHAPED UP SINCE AUGUST 2024 MONETARY POLICY?

Since the August 2024 policy, there have been interesting developments on the domestic front and the global front.

6. The Q1FY24 GDP for the quarter ended June 2024 was announced towards the end of August. At 6.7%, the GDP growth was sharply lower than the previous 4 quarters, when it had averaged above 8%. However, scratch the surface, and the problem is inflation and not economic activity. In fact, the nominal GDP growth in the first quarter was higher; but the real GDP growth got impacted by the higher inflation reading. While agriculture growth had come under pressure, the manufacturing and most of the services continued to be robust. The RBI MPC has to take a call on whether their projection of 7.2% for FY25 is feasible, but they would ideally wait for the second quarter data also, before taking any call on tweaking full year GDP growth projections.
7. The second big data point in the interim period was the current account deficit for the first quarter ended June 2024. At $9.7 Billion, the current account deficit (CAD) was not only higher on a yoy basis but also on a sequential basis. In the year ago period, the CAD was 1% of GDP, while in the sequential fourth quarter of FY24, India had reported a current account surplus. The spike in the current account deficit was on account of a spike in the merchandise trade deficit and the services surplus struggling to keep pace. The full year CAD may now inch closer to 2% of GDP, which is relatively higher by the standards of the previous year.
8. During the interim period between the August and October MPC meets, the US Fed embarked upon its rate cut program. It had led rates static since July 2023 on inflation fears. However, with rising unemployment, which had reached 4.3% in July and is still around 4.1% as of September, the Fed has shifted its focus to ensuring full employment. That is defined as 3.5% unemployment. Recent Fed statement have indicated that they believe that enough has been done on the price stability front and it was now time to ensure that the growth levers were put in motion. That is something the RBI should also watch out, especially with the core sector growth contracting by -1.77% in August, the lowest level in the last 42 months.
9. The big challenge that has developed in recent weeks is the risk of Israel and Iran going to an all-out war. The impact on oil is likely to be felt, but there are larger repercussions. Most of the GCC nations have remained neutral till date, but they may come under increasing pressure to be vocal if the casualties in Iran and Lebanon start rising. The US has been neutral with its upcoming presidential elections but things may change once the elections are over and the Middle East situation could change sharply.

Clearly, the Fed dovishness and the geopolitical risks are going to weigh the most on the eventual RBI MPC decision. Let us now look at specific expectations.

WILL THE RBI RATE CUTS IN OCTOBER 2024?

RBI has kept the repo rates at the current level of 6.5% since February 2023. Effectively, the October 2024 monetary policy could be the 10th policy in succession when the RBI would not have tinkered with the repo rates. There are two arguments in favour of rate cuts by the RBI. Firstly, the inflation has come down below the target of 4% for two months in a row. Secondly, the dovishness shown by the Fed also poses a risk to the RBI stance. Not cutting rates at this juncture would run the risk of monetary divergence, since the Fed has already embarked on a sustained rate cut program. But the RBI MPC also has legitimate reasons for not tinkering with the repo rates in the October 2024 policy meet.

There are 3 factors that could support the RBI MPC to maintain status quo on rates. Firstly, the rising geopolitical risks are likely to translate into imported inflation for India. That may eventually manifest in the form of higher inflation in the coming months. Secondly, while food inflation is likely to be tempered by the record Kharif output, fuel inflation and core inflation are likely to remain sticky. That may push up inflation in the coming months. Thirdly, any rate cut will weaken the rupee. With the RBI struggling to defend the level of ₹84/$ with dollar selling, the RBI MPC would not want to cut rates and make the task more difficult for the RBI. A weak rupee has larger repercussions for cost of imports and also the cost of inputs for Indian companies.

COULD THE RBI CHANGE THE MONETARY STANCE TO NEUTRAL?

If you look at the RBI MPC minutes of June and August; there has been a subtle shift. Jayanth Varma and Ashima Goyal had voted in favour of cutting rates by 25 bps and also shifting the stance of the monetary policy to “Neutral.” Jayanth Varma of IIM Ahmedabad has persistently opposed static rates and holding status quo on monetary policy. According to Varma, the situation is ripe for a 25 bps rate cut as the RBI may be forcing the Indian economy towards mediocre growth. Secondly, Jayanth Varma also had highlighted that the current stance of “gradual withdrawal of accommodation” is not relevant any longer and is virtually out of sync with the market liquidity reality.

Will the RBI shift the policy stance to neutral? If you look at the process flow in the US, they first embarked on rate cuts and Jerome Powell has underlined that the change in stance would only happen at a future date. The RBI may also adopt a similar approach wherein they would first embark on rate cuts and then look to change the stance of the policy to neutral. Rate cuts are more of an operational mechanism, while a change in stance has larger implications for the level of inflation and also for inflation expectations of consumers. Hence, it is unlikely that the RBI would look to change the stance of policy in October 2024.

RBI MPC MAY JUST CAUTION ABOUT INFLATION RISKS

The FY25 inflation target was pegged at 4.5%, a good 90 bps below the FY24 inflation level of 5.4%. That means, the RBI has already pegged a sharp fall in inflation in FY25. The early indications that we are getting from food inflation and headline inflation is that the average inflation in the first half of FY25 could be higher than that. However, with last two months of sub-4% inflation, India may be getting closer to the 4.5% inflation target in the first half of FY25. It is true that the current geopolitical situation is vulnerable to a sudden spike in Inflation. It may be too early for the RBI to make any changes to the full year inflation projection until there is more clarity. Hence, the best that the RBI MPC may do is to caution the markets that inflation risks were rampant and had escalated due to recent geopolitical events in West Asia. That is, perhaps, as far as the MPC would go in the October 2024 meet.

FY25 GDP WILL BE A TOSS-UP BETWEEN FLAT AND LOWER GDP GROWTH

In the June policy, the RBI had raised the GDP growth estimates for FY25 by 20 bps from 7.0% to 7.2%. however, in August, the RBI MPC did not tinker with the GDP growth. With the RBI pegging full year FY25 GDP growth at 7.2%, upsides look to be a tough call at this point. Hence, any guidance on GDP would be either flat or lower. However, it must be remembered that any downsizing of GDP projection by the RBI MPC would raise the clamour for immediate rate cuts and hence the RBI MPC would prefer to be data driven. By the time of the December policy meet, the second quarter GDP data will also be out, giving the RBI the perfect platform to take an unbiased data-driven view on full year GDP for FY25.

PERCEPTION 101 – WHAT WILL THE RBI MPC ACTUALLY DO?

There is a lot of talk about how the Fed policy will influence the RBI monetary policy. In reality, one should not be surprised if the RBI disassociates completely from the interest rate dovishness in the US. It may prefer to take an independent view on the domestic rates based on evolving conditions. In short, for the RBI MPC, domestic conditions will remain paramount. If the US Fed cuts rates then it will weaken the dollar and strengthen the rupee. Any decision on rates in the backdrop of the US rate action will also have to consider the rupee impact in the equation.

For October 2024, the RBI is likely to continue with its current stance of “gradual withdrawal of accommodation.” However, there is a strong possibility that the RBI may also get into rate cut mode from December 2024 or latest by February 2025. Some of the high frequency indicators like core sector growth are showing pressure. Weakening momentum in growth could be a key driver for the RBI to eventually embark on rate cuts. When that will happen is still an open debate!