IGI Logo

RBI makes first move towards easing cycle

Key takeaways: The RBI Monetary Policy Committee (MPC) held the policy rates steady at 6.5% and maintained the stance at Neutral. It however cut cash reserve ratio (CRR) by 50bps to 4%, which was in line with our and consensus expectations. The CRR cut in today’s policy allows the RBI to address growth concerns as also risks to the Indian Rupee amid the strength in the USD and continuous FII outflows. With food inflation pressures likely to ease starting January 2025, headline inflation may come closer to 5%, allowing the RBI’s MPC space to address growth concerns after the recent dismal GDP growth of 5.4% vs market expectation of 6.5%. We expect MPC to cut policy repo rate by 25bps in Feb 2025E and expect a total of 75bps rate cut this easing cycle.

CRR normalization to ease liquidity conditions, going forward: The RBI’s pre-emptive move to cut the CRR by 50bps to 4% matched our expectations, as potential challenges to durable system liquidity have increased incrementally, in our view. On the external front, the INR is overvalued on real effective exchange rate and remains under continuous downward pressure especially on the back of USD strength. In support of the INR, the RBI holds ~USD 60-65bn in forwards, (likely half of them in the 1m-3m period) and should RBI take their deliveries, it would further drain systemic liquidity at a time when Q4FY25 is likely to see durable liquidity turning into deficit. As such, a CRR cut was a prudent move as it allowed room for RBI to address INR weakness while also signaled its readiness to act.

Domestically, a repo cut may not have brought effective rate cut transmission in the system amid anticipated tighter liquidity conditions in the upcoming months due to tax outflows, advance tax payments, higher demand from agriculture sector post harvest. Hence, the move to ease liquidity in the banking system (expected to release primary liquidity of ~INR 1.16tn in the banking system, as per RBI) was a more prudent move in our view before policy rate cuts.  Durable and system liquidity peaked at INR 4.9tn and INR 2.7tn respectively because of FX outflows.    

Growth and inflation risks up: Given the downside surprise in Q2FY25 growth, the RBI lowered its FY25 GDP growth projections to 6.6% (Elara estimates at 6.5%) versus 7.2% previously. The RBI remains positive on growth impulses in H2FY25E, led by positive trends in rural demand, improving spending by the government and external demand buoyed by services exports.

On the inflation side, while the RBI held its confidence as regards inflation subsiding in Q4FY25E, a ~90bps bump in Q3 projection versus last meet’s projection led the RBI to raise FY25 projections by 30bps to 4.8% (Elara estimate at 4.8%). Better sowing outlook for the Rabi crop, adequate reservoir levels, record Kharif production and seasonal price corrections in vegetables may inject downside pressure in food prices and hence, on headline inflation, per the RBI. We however expect this to playout not before Jan 2025.      

Measures supporting INR welcome: Indirect measures to support the INR via liquidity measures and raising interest ceilings on FCNR (B) deposits (1-3m tenure) have the potential to ease some depreciation pressure on the INR in the near term. Adding to this, the introduction of Secured Overnight Rupee Rate (SORR) based on ONREPO and TREPS can lend incremental support to the INR due to positive carry potential over major market rates such as SOFR (191bps) and SONIA (180bps). Not to forget, the USDINR still remains the least volatile unpegged EMFX, even as iVols have increased by ~30% Q3FY25TD in three-month and six-month forward tenors.

However, in our view, moves in the USDINR and overall, Asia EMFX remain mainly a function of the USD for now and BoJ policy, over domestic idiosyncratic factors.

Outlook – Expect 25bps cut in Feb ’25E: We expect the MPC to cut policy repo rate by 25bps in Feb 2025E and expect a total of 75bps rate cut this easing cycle. The CRR cut following the change in stance in previous meeting paves the way for further policy easing in the form of rate cuts. While Q3FY25 GDP growth is likely to be higher than Q2FY25 level, the impact of RBI’s macro-prudential policies (to check the excesses in credit growth) and of sluggish government spending may take time to wear off.

We expect FY25E GDP growth at 6.5% versus RBI’s estimate of 6.6%. The CRR cut in today’s policy leaves scope for the RBI to address growth concerns as well as external risks amid firming USD and FII outflows. As food inflation pressures begin to ease starting Jan 2025, headline inflation shall likely come closer to 4.5-5%, allowing the MPC space to address growth concerns. By then, there will also be clarity on Trump’s policy decisions when he assumes power and on the Fed’s policy outcome in December and Jan end.  

Above views are of the author and not of the website kindly read disclaimer