RBI signals cautious optimism on growth-inflation balance

All members of Monetary Policy Committee (MPC) unanimously decided to continue with the neutral stance and to remain unambiguously focused on durable alignment of inflation with the target, while supporting growth. 

To support the overall liquidity conditions, RBI decided to lower the cash reserve ratio (CRR) to 4% from 4.50%.

GDP and inflation forecasts revised

The RBI lowered the real GDP growth forecast for FY25 to 6.6% from 7.2%. Moreover, the Q1FY26 GDP forecast has been reduced to 6.9% from 7.3% while forecasting the growth at 7.3% for Q2FY26. 

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The lower GDP growth in Q2FY25 at 5.4% has mainly been driven by shrinking private consumption expenditure and investment growth. The manufacturing purchasing managers’ index (PMI) felt to 56.5 in November’24 from 57.5 in October’24 while the services PMI narrowly declined to 58.4 in November’24 from 58.5 in October’24. However, the high frequency indicators suggest that the domestic economic activity have bottomed out in Q2FY25 and has since recouped support from the festive season followed by an uptick in rural activities. This may help some uptick in GDP growth in H2FY25.

After the October ’24 inflation data came in at over 6%, the RBI revised the FY25 inflation forecast to 4.8% from 4.5% in its Oct ’24 policy. As the monsoon season comes to an end, the food inflation is likely to decrease in Q4FY25 with kharif harvest arrivals. Moreover, the superior soil conditions with decent reservoir levels are likely to assist in rabi production. Also, energy prices have come down in the recent past. 

However, adverse weather conditions and the rise in global commodity prices, increased geopolitical uncertainty and market volatility pose a risk of inflation. Considering all the factors, the RBI expects the risk to be balanced evenly. RBI projected inflation at 4.6% for Q1FY26 and 4.0% for Q2FY26.

Liquidity infusion and rate cut prospects

Persistent FPI outflows and RBI intervention in the forex market by selling dollars have resulted in a reduction in core liquidity in the Indian economy. Therefore, to infuse liquidity in the system, the RBI has cut the cash reserve ratio (CRR) by 50 bps to 4%. This will be done in two tranches on 14 and 28 December with 25 bps in each tranche which will release Rs. 1.16 trillion of liquidity into the system. 

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RBI further indicated that with the upcoming December instalment of advance tax, monthly GST outflow and likely increase in currency in circulation due to a pick up in agricultural activity, the liquidity condition is expected to remain tight going into the last quarter of the financial year.

Given this backdrop, we expect RBI to provide further support to liquidity through various measures such as OMO purchase, VRR etc. To limit the impact of forex intervention on INR liquidity, RBI has increased activity in NDF market with RBI short forward book at $49.2 billion as of October end.

RBI has allowed banks to raise FCNR deposits at higher rates by increasing the interest rate ceilings by 150 bps. This is unlikely to have any material impact in near term as interest rates being offered by banks are below the current ceiling.

We observed that RBI was more balanced in its commentary in this policy between inflation and growth vis-à-vis last few policies which was more focus on inflation. RBI Governor mentioned that “a growth slowdown – if it lingers beyond a point – may need policy support". 

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RBI has remained prudent with its policy rate and stance and has appropriately taken much needed steps to spur liquidity in the banking system. We expect the rate easing cycle to start in Feb’25 with a 50 bps rate cut in H1CY2025 and liquidity measures from RBI continuing in Q1CY2025. This strengthens the case for long India government bonds in light of overall macro stability and likely rate cuts ahead.

Deepak Agrawal, CIO- Debt, Kotak Mahindra AMC.