The Monetary Policy Committee (MPC) of the RBI maintained status quo on repo rate at 6.50% in its Dec-24 policy review, while retaining the stance at “neutral”. 

In particular,

• The RBI announced 50 bps reduction in CRR to 4.0%
• 4 of the 6 MPC members voted for status quo on rates, with the exception of Dr. Nagesh Kumar and Prof. Ram Singh 
• All the six MPC members voted to continue with the neutral stance of monetary policy and to remain unambiguously focused on a durable alignment of inflation with the target, while supporting growth.

Macroeconomic Outlook

Taking on board the downward surprise in Q2 FY25 GDP, the central bank revised its FY25 GDP growth lower to 6.6% from 7.2% earlier.

On the other hand, CPI inflation forecast for FY25 was upped to 4.8% from 4.5% earlier. This incorporates the unanticipated inflation spike over Sep-Oct-24 led by vegetables, the expectation of food price pressures still lingering in Q3 FY25, along with adverse weather events and a rise in global agri commodity prices. 

The revised FY25 GDP and CPI inflation forecasts are in line with our expectations. On growth, post Q2 FY25 GDP, we have lowered our forecast to 6.4% from 7.0% earlier. We had also upped our FY25 CPI inflation forecast to 4.8% from 4.5% earlier, post the Sep-Oct-24 spike in inflation.

Key regulatory and developmental announcements

• The reduction in CRR by 50 bps will unfold in two equal tranches of 25 bps each to 4.0% of NDTL with effect from the fortnight beginning 14th Dec-24 and 28 th Dec-24, respectively. This will add primary liquidity of about Rs 1.16 lakh crore to the banking system. 
• In order to attract more capital inflows and strengthen the INR, RBI enhanced the interest rate ceilings on FCNR(B) deposits by 150 bps. With immediate effect, banks are permitted to raise fresh FCNR(B) deposits of 1 year to less than 3 years maturity at rates not exceeding ARR plus 400 bps and deposits with maturity between 3 to 5 years at rates not exceeding ARR (Alternative Reference Rate) plus 500 bps. This relaxation will be available till 31^st Mar-25. 

Liquidity and g-sec view

We retain our view on 10Y g-sec yield drifting lower towards 6.50% by Mar-25, on account of:

• Greater visibility on the commencement of monetary policy easing from the RBI in the foreseeable future 
• Bond index-related foreign buying. India’s inclusion in the three EM bond indices i.e., - JP Morgan, Bloomberg, and FTSE Russel would result in USD 30-35 bn of passive debt inflows before the end of FY26. This will lower the supply pressure at a time when the fiscal deficit has been narrowing. 
• Although the proposed changes in the LCR framework by RBI is in the discussion stage, its implementation in the current form could result in an increase in HQLA-led demand for g-secs, thereby providing further downside to g-sec yields. We will monitor this regulatory development for further cues. 

Outlook

• The run-up to the Dec-24 policy review had turned out to be quite eventful. On the one hand, the inflation upsurge over Sep-Oct-24 turned out to be substantial, led by food price pressures. Adding to the apprehensions was the more than-expected downside in Q2 FY25 GDP growth momentum. Both these warranted a revision to FY25 forecasts. Against this backdrop of growth-inflation dynamics, the RBI was also drawn into managing rupee volatility, amidst heavy selling by FPIs.  
• Against this backdrop, the Dec-24 monetary policy decisions need to be seen from three perspectives –
  1. One, the status quo on rates reinforcing RBI’s continuing commitment to align inflation to its target over the medium term.  
  2. Two, the cut in CRR will help partially sterilize the impact of RBI’s recent FX intervention, easing system liquidity and hardening of money market spreads. 
  3. Third, the hike in the deposit rate ceiling for NRIs will offer added support to the domestic currency.  
• While RBI expects growth to recover in Q3 FY25, it will monitor the evolving outlook closely. In a similar vein, while the inflation upsurge is expected to start easing beginning Nov-24, the disinflation needs to be seen through for its magnitude as well as longevity through Q4 FY25. 
• As per RBI’s commentary, “At this critical juncture, prudence and practicality demand that we remain careful and sensitive to the dynamically evolving situation with all its complexities and ramifications”

In our view, a likely pivot in monetary policy is possible at its next meeting in Feb-25 for the following reasons: 

• A record Kharif production and bright prospects for Rabi output are likely to impart disinflationary food impulses well into Q1 FY26.

• GDP growth in H2 FY25 is expected to be below RBI’s assessment. Our implied GDP growth for H2 stands at 6.7-6.8% compared to RBI’s estimate of 7.0%. The ongoing global uncertainties and with Trump assuming power in Jan-25, could tilt the balance of growth somewhat adversely in FY26.
• The continued commitment of the central government to pursue the path of fiscal consolidation (Budget to be presented in early Feb-25) is likely to offer RBI the comfort to begin easing its rate cycle. 

We now expect a 25-bps rate reduction in FY25, followed by an additional 50 bps reduction in H1 FY26. The soon-to-commence rate easing cycle, however, is likely to be shallow as -

• The central bank is committed to ensuring inflation attains its target on a durable basis rather than a few quarters
• Real rates provide a limited latitude for downward adjustment (as per the RBI, the strong post-Covid recovery has resulted in the estimate of India’s natural rate moving up to 1.4-1.9% range from its earlier estimate of 0.8-1.0% range in FY22).
• Fiscal deficit is yet to align with its pre-Covid low of ~3.5% of GDP
• Market expectations with respect to the magnitude of US monetary policy easing have pruned significantly in recent weeks on account of lingering resilience in the US macroeconomy and Trump’s return to power which may lead to higher US inflation.  

Says Suman Chowdhury, Chief Economist and Executive Director, Acuité Ratings & Research, “RBI governor's statement for the latest MPC highlights the increased dilemma on growth-inflation balance, amidst sticky headline inflation and a slowdown in growth seen in Q2.

As expected, MPC has attempted to address it by a cut back in CRR by 50 bps while keeping the status quo on the benchmark rates. Higher system liquidity will soften short term interest rates, reduce the pressure on bank deposit rates and facilitate credit growth which have showed signs of slowing down.

RBI had to modify its forecasts on growth and inflation given the latest data prints. There is a significant downward revision in GDP growth to 6.6% from the earlier 7.2%, which is still 20 bps higher than our revised forecast of 6.4%.

Given the slower decline in food inflation in the current quarter, RBI has also revised its average inflation forecast to 4.8% from 4.5%, which is almost 1% higher than the target level.

In particular, RBI's forecast for Q4 has been raised to 4.5% which highlights the challenges of bringing down the headline inflation near to 4%. This, therefore, will continue to keep some uncertainty on the expected rate cut in Feb-25. The new global normal with improved US economy, lower rate cuts by Fed and a stronger USD have also made it difficult to go for a rate cut without a material weakness in the growth trajectory as we go forward.”