Monetary Policy:Why RBI May Not Be In Hurry To Cut Rates Despite Growing US Recession Fears?

The Reserve Bank of India (RBI) is likely to keep its repo rate unchanged for the ninth time in a row on August 8, despite the resilient economic growth of the country. RBI's key rates decision comes at a crucial juncture where the US Federal Reserve is resorting to a $50 billion buyback in three months starting August, to support liquidity as concerns of recession grow.

The key difference between RBI and the US Federal Reserve's decision to pause on rates despite when other global central banks have already started to cut key interest rates is that India's central bank has much more leisure for a repo rate cut than the US Fed.

Now, experts are factoring in an emergency rate cut by the US Fed, way before the expectation of a September cut. Fed has been criticized for stretching too long when both inflation and employment rates witnessed significant improvement in recent times.

As per Emkay Global, to be fair, one can argue that macro data only justifies a portion of the panic in global market moves. After all, the US is still experiencing growth in incomes, resilient consumer spending and business investment, and some unique structural changes in the labour force. Nonetheless, the changed narrative of a growth scare and fear of a policy mistake by the Fed is unlikely to keep the MPC unperturbed.

Emkay's note further said, "We have long maintained that the RBI policy has been somewhat pegged to the Fed, specifically over the last 2.5 years, even as it formally targeted inflation. This seems fair, as external dynamics have been fluid, implying that the policy prerogative needs to be flexible for ensuring financial stability."

However, the brokerage also believes that staying relatively hawkish will only create an unwanted INR carry, and increase the problem of plenty for the RBI.

Nonetheless, Emkay continues to see easy/surplus system liquidity in H1. While the upcoming policy may not see any rate action, issues like 1) case and timing of policy pivot/stance change, and 2) factors influencing liquidity management ahead would be key for markets.

Moreover, Emkay is expecting softness in the policy tone, recognizing emanating macro forces and market risks. While curve steepening looks to be a popular trade, the consistent repricing of Fed cuts and further unwinding of the Yen carry trade could spill over into the RBI's reaction function and will be cyclically noisy for bonds/FX, in the brokerage's view.

Similarly, economists at HDFC Bank do not expect a rate cut in August policy. HDFC Bank's note said, "We do see an increasing possibility of either a change in stance to neutral (current stance at "withdrawal of accommodation") or a dovish pivot in the RBI's rhetoric in this policy."

Here are the key factors that could influence RBI's decision on August 8 as per HDFC Bank's earnings:

- Fed rate cut in September highly likely: For one, expectations of a rate cut by the Fed have increased significantly over the last few weeks, with calls for a 50bps rate cut as early as September and cumulative rate cuts of 115bps expected in 2024. While some of these expectations do seem overstretched at this stage, we do see a high chance of the Fed starting its rate cut cycle in September - delivering a cut of 25bps. This could have implications for the rupee and the RBI could start aligning its monetary policy with the global rate cycle to reduce any significant future policy deviations.

- Monsoon progress has improved -bodes well for food inflation: Monsoon progress has been healthy with overall rainfall at +6% above the long-period average. There are deviations across different regions - with the south recording excess rainfall and the northwest seeing deficient rainfall - but the distribution is expected to improve as the monsoon season progresses. Kharif sowing is also above last years' level for major crops like rice and pulses. To this extent, food inflation risks seem broadly manageable and "not increasing in persistence" at this stage.

Core inflation has been low: Core inflation has been moderating for over 12 months now and while we could see some pick-up over the coming months (due to base effects, telecom tariff increases and some recovery in demand) it is still expected to average between 4-4.5% for FY25.

Liquidity balance has improved: Over the last month, system liquidity balances have moved into a surplus due to higher government spending and as the RBI absorbed dollar inflows -- injecting rupee liquidity -- to manage rupee volatility. While the RBI has regularly conducted VRRR operations to absorb surplus liquidity, the WACR (weighted average call rate) has averaged below the policy rate at 6.44% in July 2024 and the central bank seems to be a little bit more comfortable with some liquidity surpluses in the system.

Bottom-line is that the RBI could use this policy to set the stage for an eventual rate cut later this year. If this were to happen, we could see further down moves in bond yields with the 10-year yield moving towards 6.80% levels, as per HDFC Bank's economists.

Furthermore, Anand Rathi's analysts in their note said, "With retail inflation still above the RBI's target rate and high weights of volatile food products in India's retail basket, the RBI would be circumspect about cutting policy rates pro-actively. At the same time, the coming policy is likely to feature a dovish commentary, reflecting the evolving economic landscape, thus indicating that rate cuts are not far away."

RBI's policy decisions align with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent while supporting growth. The latest consumer price index (CPI) rose to a four-month high at 5.08% in June 2024, owing to a sharp spike in food prices. The latest print is below the market's estimates and was also the fastest surge since February 2024.

In the June 2024 policy, RBI kept the repo rate under the liquidity adjustment facility (LAF) unchanged at 6.50%. Consequently, the standing deposit facility (SDF) rate remains unchanged at 6.25% and the marginal standing facility (MSF) rate and the Bank Rate at 6.75%.