In line with our and market expectations, the Monetary Policy Committee (MPC) of the RBI at its third bi-monthly meeting for FY25, maintained status quo on repo rate at 6.50%, while retaining its policy stance of ‘withdrawal of accommodation’.  This marked the ninth consecutive monetary policy review of no action on rates accompanied by an unchanged stance.

• Status quo on rates and stance was backed by 4 out of 6 MPC members. 
• Prof. Jayanth Varma and Dr. Ashima Goyal voted for a 25 bps cut and a change in stance to ‘neutral’.

Macroeconomic Outlook

The central bank retained its FY25 GDP growth and CPI inflation forecast of 7.2% and 4.5% respectively. However, there were a few underlying minor tweaks:

• GDP growth forecast for Q1 FY25 was revised lower by 20 bps to 7.1%. Meanwhile, quarterly forecasts for Q2, Q3, and Q4 FY25 were retained at 7.2%, 7.3%, and 7.2% respectively. The forecast for Q1 FY26 was introduced at 7.2%. 
• CPI inflation forecast for Q2 and Q3 FY25 was revised up by 60 bps and 10 bps to 4.4% and 4.7% respectively. This highlights the uncertainty on the trajectory of food inflation over the next few months. In contrast, inflation forecasts for Q4 FY25 saw a downward revision by 20 bps to 4.3%. The CPI inflation forecast for Q1 FY26 was introduced at 4.4%.

Key Regulatory and Developmental Announcements

• The RBI has proposed to create a public repository of digital lending apps. This is expected to address problems from unauthorized digital lending apps, while aiding an orderly development of the digital lending ecosystem. This comes on the heels of the Digital payments Intelligence Platform, which was announced in Jun-24 policy review to help prevent and mitigate digital payment frauds.
• Reporting of credit information by lenders to credit information companies will now be on a fortnightly basis, instead of monthly. This will help both borrowers (via faster updation of their credit assessment) and lenders (via better risk assessment of borrowers).
• There were three key enhancements to the payment systems in the form of (i) increase in transaction limit for tax payments via UPI, (ii) introduction of Delegated Payments via UPI, and (iii) transition from the current ‘batch processing’ cheque settlement to ‘on-realisation’ settlement. While the first two measures would boost UPI’s coverage further, the latter would shrink the cheque clearing cycle from the present T+1 day to a few hours.

Messages on Financial Sector Stability

• While highlighting the resilience and the capital adequacy of the Indian financial system, RBI has also highlighted a few potential risks for which the regulated entities (banks and NBFCs) need to take necessary steps. 
• Noting the consistent gap between credit and deposit growth, RBI has acknowledged the ongoing challenge in bank deposit mobilization amidst attractive investment avenues. This can lead to increased dependence on shorter term bulk deposits that in turn can create structural liquidity issues. It has advised banks to focus on branch deposit mobilization in a bigger way to mitigate the inherent volatility in larger ticket and shorter term deposits.
• RBI has also pointed out the risks of possible deployment of funds for speculation (like stock markets) from asset based retail loans like home equity (top up on home loans) and gold loans. It has advised banks and NBFCs to monitor the end use of such loans. 
• Further, it has continued to sound out caution on growth of personal loans. Excessive leverage through retail loans can lead to unsustainable levels of debt burden for individuals particularly during an economic slowdown.

Takeaways and Conclusion

Since the last policy review in Jun-24, most macro-financial variables have started to lean towards a softer monetary policy stance.

• Globally, out of 38 central banks tracked by the BIS, while 4 have hiked their monetary policy rate at least once in 2024, 19 of them have chosen to cut rates at least once in 2024. As global inflation pressures recede, more central banks are likely to join the rate easing camp. Amongst the most prominent ones would be the US Fed, which is likely to commence its rate easing cycle from Sep-24 onwards. The recent spate of soft economic data in the US has prompted market participants to aggressively price in ~100 bps cumulative rate reduction before end 2024.
• Most international commodity prices (barring precious metals) have shown a moderating trend despite the prevalence of geopolitical uncertainty. Since May-24, the World Bank’s industrial metals index is down by 8.1%, Brent crude has declined by 7.5%, and World Bank’s food price index is softer by 3.6%. This also offers some relief to net commodity importers like India.
• The FY25 Union Budget upped its emphasis on fiscal consolidation by pruning the fiscal deficit target by 20 bps to 4.9% of GDP vs. the interim budget estimate. This is intended to be achieved while maintaining the Capex/GDP ratio at a two decade high of 3.4%. Fiscal discipline with focus on quality of adjustment is likely to provide a supportive backdrop for a sustainable inflation management.
• For the first time in the current monetary tightening phase, the RBI has projected two consecutive quarters of sub 4.5% CPI inflation (4.3% in Q4 FY25 and 4.4% in Q1 FY26). Our early assessment indicates that CPI inflation for Q2 FY26 could also remain in the 4.0-4.5% range. This is as close as one could get to RBI’s intention of aligning inflation with the 4% target. We believe this would provide more clout to the doves within the MPC.

While the above-mentioned factors do support a pivot by the RBI by the end of third quarter, persistence of food inflation risks in the near-term continues to impart a sense of caution. Over the last 8 months, food inflation within CPI has averaged at 8% primarily because of weather related disruptions. Although a strong favourable base effect will pull down food inflation towards 5.5-6.0% range in Q2 FY25, the descent thereafter could suffer from stickiness. Fortunately, risk mitigants have emerged, which would help in dousing food inflation pressures in the coming months:

• Strong revival in southwest monsoon (while June recorded a deficit of 11%, July recorded a surplus rainfall of 10%, while August so far has seen 42% surplus rainfall)
• Improvement in reservoir levels
• Forecast of emergence of La Nina conditions in the second half of the monsoon season (this bodes well for good rainfall in the coming months)
• Surplus buffer stocks with the government
• Signs of moderation in global food prices

Notwithstanding the tailwinds to a softer inflation trajectory, the central bank, backed by the broad comfort on growth would prefer to remain cautious, while ensuring that the inflation target is within reach. Any premature hint of easing could potentially jeopardize past gains, while also posing challenges for maintaining a sustainable systemic credit-deposit ratio.

As such, the MPC is likely to maintain its anti-inflation posture until food inflation uncertainty persists. Since we expect food inflation risks to start abating over the next few months, the likelihood of a pivot by the MPC may increase by end of Q3 FY25. Overall, we maintain our expectation of a 25-50 bps cumulative rate reduction by H2 FY25. The expected rate easing cycle though is likely to be shallow:

• The central bank is committed in ensuring inflation attains its target on a durable basis rather than only for 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

Liquidity and G-sec View

In recent weeks, core liquidity (headline liquidity adjusted for government’s cash balances with the central bank) surplus has increased towards 2.3% of NDTL (Rs 5.0 trillion) on account of subdued seasonal demand for cash, moderate deposit growth, and RBI’s reserve accumulation. Since the RBI usually considers 1.5% of NDTL as a threshold for liquidity surplus getting inflationary, one could expect continued policy action for mopping up the surplus liquidity. We had indicated earlier that while the central bank could deploy long dated VRRR auctions or use the SDF window, the likelihood of an OMO sale cannot be ruled out – in this context, it is worth noting that the RBI has already conducted Rs 101 bn OMO sale in Jul-24 so far. This could get scaled up further towards Rs 400-500 bn in the coming months.

G-secs yields remained stable amidst no major surprise in today’s policy outcome, with the 10Y yield closing at 6.88%. We continue to expect 10Y g-sec yield to moderate gradually towards 6.75% levels by Mar-25, on the back of:

• A marginal downward revision to the FY25 borrowing target 
• Start of rate cuts by the RBI in H2 FY25
• Bond index related foreign buying (since the announcement of India’s inclusion in the JPM bond index in Sep-23, the country has received USD 16.3 bn in portfolio debt inflow)
• Although the RBI’s proposed changes in the LCR framework are at a discussion stage, its implementation in the current form could result in an increase in HQLA-led demand for g-secs, thereby providing a downside risk to our yield forecast. We will fine-tune our call post the finalization of the revised liquidity guidelines.

Says Suman Chowdhury, Chief Economist and Head- Research “Aug meeting of MPC has been a complete status quo policy with no changes whatsoever in rates or stance for the ninth consecutive time. Clearly, the policy stance remains strongly disinflationary and slightly hawkish in the background of economic resilience and healthy growth momentum in the current year. 

Overall, we believe that the narrative in the latest RBI policy has reduced the possibility of a rate cut in the third quarter of the year despite the increased likelihood of rate cuts by US Fed over the next few months.”