RBI may not budge on rates in October but shift in stance likely, says BofA Securities

Bank of America (BofA) Securities, in a recent report, forecasted that the Reserve Bank of India (RBI) is likely to maintain its current monetary policy, leaving the repo rate unchanged at 6.50 per cent in the upcoming October MPC meeting. This would mark the tenth consecutive meeting where the RBI has kept the rate steady.

"The guidance from the RBI for near-term growth and inflation dynamics remains upbeat, and that rules out any material risk of a change in monetary policy guidance in the upcoming October MPC meeting. Governor Shaktikanta Das in his recent speeches has been categorically pushing back on any near-term turn, disassociating RBI's monetary policy from the US rate cuts, and talking up future growth prospects. This was further corroborated in the recent RBI bulletin, where RBI staff estimates show no growth slippage, and inflation being broadly on track to meet RBI's growth and inflation projections of 7.2% and 4.5% for FY25, respectively," said the investment bank.

Potential for a Stance Shift

However, BofA observed that incoming near-term data is much more mixed, and growth risks seemed tilted to the downside. Also, inflation is nearing its target on a four-quarter rolling basis, the closest it has been in 22 quarters. With real rates still elevated, the central bank might soon adopt a more data-dependent approach, potentially signalling a shift in stance to neutral, the global brokerage added. If the RBI were to open the door for a rate cut, this could be one of the first steps in that direction. The October meeting would also mark the inclusion of three new members to the Monetary Policy Committee (MPC), who might align with the RBI’s broader view for the time being.

Going ahead, BofA projects a gradual slowdown in economic growth and a potential decline in inflation, which could allow the RBI to cut rates in the coming months. The bank expects repo rate cuts totalling 100 basis points by December 2025, beginning in December 2024.

No Immediate Pivot for the RBI

Despite signs of slower growth and cooling inflation throughout 2024, BofA does not expect the RBI to pivot in the October MPC meeting. In recent weeks, even amid downward revisions to growth estimates and falling global commodity prices, the central bank remained optimistic about its forecast of 7.2 per cent growth for FY25. Governor Das had emphasised that the RBI would remain data-dependent in its inflation outlook, avoiding any premature shifts in policy.

While the RBI's recent forecasts were grounded in sustained inflation control and a shrinking output gap, several preconditions are aligning to allow a future pivot to a neutral stance. These included the alignment of headline and core inflation with the 4 per cent target, a neutral output gap, a global monetary easing cycle, and the shrinking gap between credit and deposit growth in India.

"Put together, the RBI will increasingly draw comfort that its policy objectives, whether it is to align headline inflation towards 4%, or shrink the gap between credit and deposit growth are on track to be met, and as the global backdrop turns weaker, the RBI can contemplate being less hawkish, which may open the door to a change in MPC stance to neutral. If they do end up changing the stance, the guidance can remain neutral," further said BofA.

RBI's Easing Options: Price or Quantity?

A key policy dilemma for the RBI is how to approach future easing. BofA pointed out that the central bank could either focus on reducing the cost of money by cutting rates or adjust the quantity of money through liquidity measures. Recent actions suggest that the RBI has already begun easing liquidity pressures by cancelling treasury bill auctions and intervening in the foreign exchange market. As credit growth slows and the festive season leads to higher cash circulation, the RBI is likely to ensure sufficient liquidity in the banking system.

BofA suggested that the RBI might eventually focus more on the cost of money rather than liquidity, particularly given slowing nominal GDP growth and weak deposit accumulation. This approach would present challenges, particularly in an environment of rising asset prices, which could be exacerbated by any early rate cuts.

Growth and Inflation Forecasts Unlikely to Change

According to BofA, the RBI is not expected to make significant changes to its near-term forecasts. While the second quarter of FY25 might see slightly downgraded growth projections due to weaker data, the central bank is likely to revise upward its forecasts for the second half of the fiscal year to maintain its overall 7.2 per cent growth target.

"We expect RBI to remain positive on the medium growth outlook, as reflected in recent guidance, reflecting domestic fundamentals, in the form of good agriculture activity, strong services growth, in the face of weaker external conditions," said BofA.

In its latest ‘State of the Economy’ article, the RBI doubled down on its growth projections. In its model estimates, economy  is set to pick up pace in the coming months, but a material slowdown is projected going into 2025, to below 7%.

Inflation forecasts are expected to remain broadly in line with the RBI’s previous estimates. The recent drop in crude oil prices provided downside risks to inflation, but the central bank might adopt a cautious approach, reflecting its confidence in a resilient domestic growth outlook. The upcoming mid-year monetary policy review, which would include the RBI’s medium-term growth and inflation projections, could offer further insights into the central bank’s rate expectations. Market participants would closely watch this review for signals about future policy moves.

In conclusion, while the RBI is expected to hold the repo rate steady in the October MPC meeting, the possibility of a future shift in stance is becoming more likely. Slowing growth and easing inflation pressures could eventually create room for rate cuts, potentially starting in December 2024.

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