RBI Monetary Policy Preview: Easing Inflation, GDP Growth Concerns Could Mean Rate Cut

The Reserve Bank of India's Monetary Policy Committee will meet from Feb. 5-7 for policy review, soon on the steps of the union budget last Saturday. This is the first MPC meeting after the appointment of Governor Sanjay Malhotra and the re-designation of Rajeshwar Rao in the monetary policy department, and the second MPC meeting for the three external members — Ram Singh, Saugata Bhattacharya, and Nagesh Kumar.

Of the 28 economists polled by Bloomberg, 24 expect the MPC to cut the repo rate on Friday, with Abhishek Gupta of Bloomberg expecting a deeper rate cut of 50 basis points and the remaining expecting a rate cut of 25 basis points. The benchmark lending rate is currently at 6.5%.

Amid decelerating inflation, a brief respite from a one-way dollar rally, signs of soft domestic demand, and ongoing fiscal consolidation, onus is on the monetary policy to assume a growth supportive tone, said Radhika Rao, senior economist at DBS Bank.

Post the presentation of the union budget, Sonal Varma, India economist at Nomura, said that fiscal prudence will also keep India’s fiscal risk premia low and provide greater leeway to the RBI, to begin lowering its policy rate at the February MPC.

India's consumer price index-based inflation moderated to 5.22% in December from 5.48% in November. In October, inflation was the highest in 14 months and in excess of the RBI's upper tolerance band, before easing in November and December.

Food and beverage inflation in December eased further to 7.69%, from 8.2% in November, led by lower vegetable prices. Core inflation—that strips out volatile food and fuel prices—rose 3.6%, compared to 3.7% in November.

Liquidity remains in deficit. In what's being seen as 'rate cut by stealth', the central bank announced various special measures last week, such as the purchases of open market operations, longer tenure variable rate repo auctions and interventions in the foreign exchange market, in a bid to boost liquidity in the banking system.

A slew of liquidity measures is expected to narrow the shortfall, improving policy transmission, Rao said. Providing liquidity is important, as is easing the price of that liquidity, she added.

The gross domestic product is estimated to grow 6.4% in FY25, according to the first advance estimates released by the government. This is the slowest pace of growth in four years and compared to a provisional estimate of 8.2% for FY24.

While the second half of the fiscal is expected to see an uptick, compared to the first half, high frequency indicators and corporate earnings show the lack of any substantial improvement, despite the festive season spending.

The rupee breached a fresh low of 87 against the dollar amid US President Donald Trump's imposition of tariffs against Canada, Mexico and China.

How far can the rupee go? It will depend a lot on what the RBI will do, stated a note by Bank of Baroda. There is already some panic as importers are rushing in to book dollars, thus increasing demand.

While the buy-sell swap saw a good response, which drew out dollars from the system and induced liquidity last week, the puzzle is to manage rupee movements with liquidity because if dollars are sold, it will draw out liquidity.

"We do believe that a repo rate cut is on the cards soon, as the budget has done well to spur growth and with expectations of inflation to come down, this could be the right time," said Madan Sabnavis, chief economist at Bank of Baroda. "But the currency issue has popped up again, which can lead to some serious discussion," he cautioned.