The Reserve Bank of India’s Monetary Policy Committee faces an unenviable task as it meets this week to decide the policy interest rate. While global peers like the US Federal Reserve, the Bank of England, and the European Central Bank have initiated rate cuts to stimulate growth, the RBI finds itself in a tricky situation with high inflation, slowing economic growth, and liquidity pressures.
India’s GDP growth for the July-September quarter of FY25 has slipped to 5.4%, a sharp decline from the projections of around 6.5%. This marks the lowest growth rate in seven quarters, driven by industrial deceleration and weaker investment demand. The slowdown has raised alarms, with most analysts agreeing that the RBI will lower its annual growth forecast to below 7%, a significant revision from its previous estimate of 7.2%.
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RBI’s concerns over sticky inflation
On the inflation front, the scenario is equally worrying. Consumer Price Index-based inflation reached a 14-month high of 6.21% in October, primarily driven by food inflation, which rose to 10.9%. While seasonal corrections in vegetable prices may offer some relief in the months ahead, core inflation—though moderate—remains sticky.
Annual inflation rate based on CPI
This dual challenge complicates policy decisions. A rate cut, while potentially boosting growth, could exacerbate inflationary pressures. Conversely, maintaining rates could deepen the growth slowdown, particularly as private consumption and investment falter.
Liquidity tightness adds another dimension
Adding to the complexity is a liquidity deficit in the banking system. The net liquidity deficit as of Thursday stood at Rs 9,489 crore, driven by the RBI’s foreign exchange interventions and temporary mismatches in government cash flows. Analysts suggest that easing liquidity through a reduction in the cash reserve ratio (CRR) or open market operations (OMO) could help alleviate pressures without altering the repo rate.
India policy repo rate (%) rate
Several economists have proposed a 25 basis-point CRR cut to inject liquidity into the system, ensuring that tight liquidity conditions do not amplify growth concerns. Open market operations, which involve the RBI purchasing government securities from banks, are also being touted as a tool to manage liquidity more effectively.
Divergence in monetary policies
Globally, central banks have shifted their focus towards rate cuts to combat economic slowdowns. The US Federal Reserve, for instance, has already reduced its benchmark rate by 75 basis points this year, with more cuts expected in 2025. Similarly, the ECB and Bank of England have initiated rate reductions, signalling a coordinated effort to stimulate growth.
However, India’s inflation-growth dynamics diverge significantly from these economies. While the Fed and others face disinflationary pressures, India’s inflation remains above the RBI’s target range. Moreover, a depreciating rupee complicates matters further, as rate cuts could widen the interest rate differential with the US, leading to potential capital outflows and increased pressure on the rupee.
The case against an interest rate cut
Despite the sharp slowdown in GDP growth, the RBI is unlikely to cut the repo rate in its December meeting. Inflation remains above the central bank’s flexible target range, and a premature rate cut could signal complacency in managing price stability. Moreover, with inflation projected to trend lower in the March quarter, the RBI might prefer to wait until February for any rate action.
The MPC’s decision will also be influenced by the transmission of monetary policy. Without adequate liquidity in the banking system, a rate cut may not translate into lower borrowing costs. Thus, measures to address liquidity tightness—such as CRR reduction or OMO—could take precedence over rate cuts.
Talking up the market
Beyond policy actions, the RBI’s communication will play a crucial role in shaping market expectations. Governor Shaktikanta Das, whose term ends shortly after this policy announcement, will need to strike a delicate balance between addressing growth concerns and reaffirming the RBI’s commitment to price stability.
In the October policy meeting, the RBI shifted its stance from ‘withdrawal of accommodation’ to neutral, signalling flexibility in its approach. However, subsequent public statements from the Governor have downplayed this shift, emphasising continuity in the RBI’s inflation-targeting mandate. This meeting will test the central bank’s ability to navigate these conflicting priorities without undermining market confidence.
The December policy meeting is poised to set the tone for the months ahead. While a rate cut may be off the table, liquidity management measures and revisions to growth and inflation forecasts will dominate the agenda. As inflation pressures ease in the coming months, the RBI could consider rate cuts in February, aligning its actions with the evolving macroeconomic landscape.
For now, the RBI’s decision will reflect a cautious, data-driven approach, prioritising stability over short-term stimulus. In a volatile global and domestic environment, this prudence may be the central bank’s most valuable tool.