The Reserve Bank of India (RBI), in its December 6, 2024, Monetary Policy Committee (MPC) meeting, opted to hold its key interest rate steady at 6.50% for the eleventh consecutive session. However, it introduced a pivotal measure by reducing the cash reserve ratio (CRR) by 50 basis points to 4%. This phased reduction, taking effect on December 14 and 28, is aimed at easing liquidity conditions amidst slowing economic growth and persistent inflationary challenges.

Slowing Economic Growth: A Key Concern

India’s economic momentum has been waning, with GDP growth for the second quarter of FY25 slipping to 5.4%. This marked the slowest pace in seven quarters and was driven by weaker manufacturing growth at 2.2% and a contraction in mining activity. Private consumption, a key driver of economic growth, also showed signs of stagnation, reflecting the challenges in reviving domestic demand.

The deceleration comes at a time when global uncertainties, including geopolitical tensions and commodity price volatility, have added to India’s economic pressures. Although rural demand exhibited resilience, buoyed by a robust kharif harvest and a favorable rabi crop outlook, the overall economic landscape remains fragile.

Inflationary Pressures Limit Room for Rate Cuts

Inflation remains a critical concern for the RBI, with the consumer price index (CPI) climbing to 6.2%, breaching the central bank’s upper tolerance limit. Food prices, driven by supply chain disruptions and erratic weather patterns, have been a significant contributor to the inflationary uptick. Despite these pressures, the RBI forecasts a moderation in inflation in the coming months, contingent on stable agricultural output and reduced global commodity price shocks.

The RBI’s decision to hold rates highlights its cautious approach in navigating the dual challenges of high inflation and slowing growth. Governor Shaktikanta Das reiterated the need for a “calibrated policy response” to ensure financial stability while fostering economic recovery.

Cash Reserve Ratio Cut: A Targeted Liquidity Boost

The 50-basis-point reduction in the CRR is expected to release approximately ₹1.37 trillion into the banking system, providing much-needed liquidity. This move is strategically significant, as it allows banks to enhance credit availability without altering the broader interest rate environment. Analysts anticipate that the additional liquidity will support sectors such as real estate, infrastructure, and small and medium enterprises (SMEs), which are particularly sensitive to borrowing costs.

The phased implementation of the CRR cut reflects the RBI’s intent to manage liquidity injections carefully, ensuring that they do not exacerbate inflationary pressures. This measure aligns with market expectations, as many economists had predicted a liquidity-enhancing move amidst the RBI’s limited room for maneuver on interest rates.

Expert Opinions on the Policy Decision

Economists and market analysts have largely welcomed the RBI’s balanced approach. Aditi Gupta of Bank of Baroda noted that the CRR cut was “in line with expectations” and emphasized its role in augmenting liquidity. She projected a potential rate cut in February 2025, provided inflation shows signs of sustained moderation.

Shishir Baijal, Chairman of Knight Frank India, highlighted the challenges faced by the real estate sector, where high borrowing costs have dampened housing demand. He underscored the importance of reducing financing costs to revive the housing market, particularly in the affordable segment.

Devendra Kumar Pant of India Ratings cautioned that inflation remains the primary risk to economic stability. He stressed that financial stability hinges on the central bank’s ability to balance liquidity measures with inflation control.

Global Comparisons and Policy Trends

India’s monetary policy decisions echo trends observed in other emerging markets, where central banks are grappling with similar challenges. For instance, many central banks have adopted a cautious stance, prioritizing inflation control while deploying targeted measures to support liquidity and growth. The RBI’s decision to cut the CRR aligns with this broader trend, showcasing its adaptability in managing complex economic dynamics.

Future Outlook: What Lies Ahead?

As the RBI prepares for its next policy review in February 2025, several factors will influence its decisions. Inflation trajectory remains a critical determinant, with the central bank closely monitoring food price trends and global commodity markets. Additionally, the effectiveness of the CRR cut in revitalizing credit growth and stimulating economic activity will be a key metric.

While the possibility of a rate cut in February remains uncertain, economists believe that the RBI’s current approach lays the groundwork for a more accommodative stance in the future. By prioritizing liquidity and maintaining financial stability, the central bank is positioning itself to respond effectively to evolving economic conditions.

Conclusion

The RBI’s December 6 policy announcement underscores its commitment to balancing growth and inflation in a challenging economic environment. By holding rates steady and introducing a targeted liquidity measure through the CRR cut, the central bank has signaled its intent to support economic recovery while safeguarding macroeconomic stability. As India navigates the complexities of a slowing economy and persistent inflation, the RBI’s decisions will play a pivotal role in shaping the country’s economic trajectory.

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Photo source: Google

By: Montel Kamau

Serrari Financial Analyst

6th December, 2024