RBI’s neutral policy stance shouldn’t raise rate-cut hopes too high

The repo rate, at which it lends overnight funds to banks, stands unchanged at 6.5%. The central bank’s other rates for lending and liquidity absorption also stay 25 basis points above and below that level, respectively. 

With the US Federal Reserve having embarked on a rate-cutting cycle, some market watchers had expected RBI to align its policy with America’s so that currency pressures don’t come into play. Headwinds faced by the global economy amid high geopolitical uncertainty had also raised concerns of slowing growth. 

But with domestic inflation still above RBI’s 4% goal, premature easing would have risked taking the lid off price pressures just as the cost-of-living was coming under control. “It is with a lot of effort that the inflation horse has been brought to the stable,” said Governor Shaktikanta Das. 

“We have to be very careful about opening the gate, as the horse may simply bolt again.” Though inflation was under 4% in July and August, the dip was more on account of last year’s price-index elevation than a real cool-off. 

This ‘base effect’ is expected to reverse, lifting inflation back above target. RBI will be hoping that such jagged readings even out soon, so that a clearer picture emerges.

As Das noted, the outlook offers much cause for comfort. Plentiful rainfall this year has brightened food production prospects, which should boost farm supplies and cool food prices. The kharif season harvest is expected to see gains, while high reservoir levels bode well for rabi crop sowing. 

But with the war in West Asia looking set to worsen, prices of commodities like crude oil are on the rise and could upset forecasts. Brent crude oil jumped from under $70 to over $78 per barrel within days of Iran’s missile assault on Israel, and a retaliatory strike on Iranian oil facilities could drive it higher. 

Oil in a range of $80-85 may still be manageable from India’s balance-of-payments perspective, but a worse upshoot could ignite local prices, given the ripple effect of dearer fuel imports. 

Brighter odds of China’s economy recovering after a big stimulus package by its central bank have driven up metal prices, even as food gets costlier globally. All these pose challenges for RBI as it prepares to shift from taming inflation to tackling incipient growth risks. 

To be sure, the central bank has expressed satisfaction with consumption and investment trends, with both seen as firming up. Yet, there’s no saying what today’s war clouds over the world may deliver. For now, RBI sees India’s economy growing 7.2% in 2024-25, unchanged from its last forecast, and inflation for the year at 4.5%.

So, with all its deliberations done, “the MPC considered it appropriate to change the stance to ‘neutral’ and to remain unambiguously focused on a durable alignment of inflation with the target, while supporting growth,” Das said. 

On the latter count, RBI is more optimistic than economists who expect sub-7% GDP expansion this year. While it didn’t lower its forecast, its switch in stance does appear to foreshadow a dovish turn in favour of growth. 

Markets, however, would be well advised not to start pricing in a prospective rate cut. Neutrality is a disposition that could go either way. RBI has given itself space to act just as the scenario demands.