The Reserve Bank of India (RBI) has kept its key interest rates unchanged at 6.50%, as widely expected, while shifting its policy stance from “withdrawal of accommodation” to “neutral.” This move, signaling potential rate cuts in the near future, comes as India faces early signs of an economic slowdown.

The decision, made by the Monetary Policy Committee (MPC)—comprising three RBI officials and three external members—marks the 10th consecutive meeting where the repo rate has remained steady. However, the change in policy stance is noteworthy, as it reflects concerns over slowing growth and moderating inflation, while still balancing the central bank’s inflation target.

Unchanged Repo Rate and Shift to Neutral Stance

India’s repo rate, which has been held at 6.50% since February 2023, is the rate at which the central bank lends to commercial banks. This rate has remained a critical tool for controlling inflation while stimulating economic growth. With inflation dropping below the RBI’s 4% target in recent months, the central bank appears more comfortable shifting to a neutral stance, which could lead to rate cuts in the near future.

In his statement, RBI Governor Shaktikanta Das noted that while there is confidence that inflation will remain contained, significant risks remain. These risks include adverse weather conditions, geopolitical conflicts, and the recent rise in commodity prices, all of which could influence inflationary trends moving forward.

The RBI’s change in policy stance has implications for India’s broader economic strategy, particularly as it seeks to support growth amid global uncertainties. By signaling the potential for rate cuts, the central bank is providing breathing room for businesses and consumers alike, who could benefit from lower borrowing costs.

Inflation in Focus: Contained but Persistent Risks

India’s annual retail inflation rate has shown signs of moderation in recent months, with August 2024 inflation coming in at 3.65%, slightly above July’s revised rate of 3.60% but still below the 4% target. Despite this positive trend, geopolitical tensions—particularly in the Middle East—have added an element of uncertainty to the inflation outlook.

The RBI remains cautious, forecasting inflation to average 4.5% for the fiscal year 2024-25, unchanged from its previous projection in August 2024. Governor Das emphasized that while inflation has been trending lower, the central bank must remain vigilant to external shocks and domestic price pressures that could arise from supply disruptions or global commodity price surges.

Several factors could influence inflation in the near term. These include rising fuel prices, which have been driven by supply-side constraints in the global oil market, and food price volatility due to erratic weather patterns, which have affected crop yields across the country. India, being a large importer of crude oil, is particularly vulnerable to price shocks in the global energy market.

Economic Slowdown and Growth Concerns

While inflation has remained manageable, concerns over India’s economic growth have begun to emerge. Data from high-frequency indicators, such as the Manufacturing PMI, showed a slowdown in September, hitting an eight-month low. Similarly, the Services PMI reached a 10-month low, reflecting weaker demand in one of the key sectors of India’s economy.

India’s overall GDP growth for the June quarter stood at 6.7%, lower than the government’s projections. This is a deceleration from earlier quarters, highlighting the challenges the economy faces, particularly as global demand softens and domestic consumption slows. While the RBI maintains its forecast of 7.2% growth for the current fiscal year, the central bank is likely to adopt a more cautious approach, especially in light of external risks and domestic headwinds.

Governor Das acknowledged the growing concerns over growth, stating that the central bank would continue to focus on ensuring the “durable alignment of inflation to target while supporting growth.” This dual mandate underscores the RBI’s delicate balancing act—encouraging economic expansion without compromising its inflation-fighting credibility.

Financial Markets Reaction: Bond Yields Fall, Equities Rise

The shift in the RBI’s stance had immediate effects on the financial markets. India’s 10-year bond yield fell by 5 basis points to 6.7392% following the announcement, reflecting expectations of easier monetary policy in the near future. Bond yields move inversely to prices, so a fall in yields suggests that investors are anticipating lower interest rates, which would push bond prices higher.

Meanwhile, India’s equity markets reacted positively to the announcement. The Nifty 50 index rose 0.67% to 25,177.5 points, and the S&P BSE Sensex gained 0.55% to 82,080 points. These gains come as investors anticipate a more accommodative monetary policy stance that could spur corporate earnings and economic activity.

On the currency front, the Indian rupee remained flat at 83.9450 against the U.S. dollar, indicating that the foreign exchange market had largely priced in the RBI’s decision ahead of time. The stability of the rupee is critical for maintaining investor confidence and ensuring that inflation does not spike due to currency depreciation.

Global Economic Environment and Geopolitical Risks

The RBI’s decision to shift its stance is also influenced by global economic conditions and emerging geopolitical risks. The ongoing conflict in the Middle East, coupled with sluggish global growth, has raised concerns about India’s export performance and the impact on key industries such as textiles, electronics, and IT services.

Global economic activity has been slowing, with several major economies—such as China, the Eurozone, and the United States—facing reduced growth prospects. For India, which is closely integrated into global trade and supply chains, any downturn in the global economy can have a direct impact on domestic growth.

The escalating conflict in the Middle East adds another layer of uncertainty. The region is a critical source of crude oil for India, and any disruptions in supply could lead to higher fuel costs, increasing inflationary pressures. Additionally, the conflict could affect remittances from Indian workers in the Gulf region, which form an important source of foreign exchange for the country.

Outlook: Potential for Rate Cuts in Early 2025

As the RBI moves toward a neutral stance, economists widely expect that rate cuts could be on the horizon. Given the current inflation trajectory and the emerging risks to growth, the central bank may opt to lower interest rates as early as the first half of 2025.

Several economists and market analysts have expressed the view that the RBI will likely wait for more data on inflation and growth before making any moves. The focus will remain on the inflation-growth balance, with a keen eye on the potential risks posed by global commodity prices, geopolitical tensions, and domestic supply-side challenges.

In conclusion, the Reserve Bank of India’s decision to maintain its key interest rate at 6.50%, while shifting its stance to “neutral,” signals a more accommodative policy approach in the coming months. With inflation under control but risks on the horizon, the RBI’s focus will remain on supporting growth while ensuring that inflation remains anchored to its target.

Conclusion: Navigating Uncertainty

As the Indian economy grapples with global challenges and domestic pressures, the central bank’s cautious approach reflects the need to balance growth with inflationary concerns. The shift to a neutral monetary policy stance is a sign that the RBI is prepared to take further action if necessary, with the possibility of rate cuts on the horizon.

This delicate balancing act will be critical for ensuring that India remains on a steady growth trajectory while keeping inflation in check, despite the uncertainties posed by global economic conditions and geopolitical risks. As the world watches, the coming months will be crucial for determining whether the RBI’s current strategy proves effective in navigating these turbulent times.

photo source: Google

By: Montel Kamau

Serrari Financial Analyst

9th October, 2024