RBI To Hold Repo Rate At 6.5% On October 6 Despite Economic Headwinds; Rate Cuts Unlikely Till Q1FY25

Six-member monetary policy committee (MPC) led by RBI governor Shaktikanta Das is once again set to meet between October 4th to 6th for the bi-monetary policy outcomes which will be announced this Friday. RBI's policy comes on the backdrop of domestic and global economic challenges. Despite this, the majority of economists believe a status quo is on the cards by RBI following the trend of the US Federal Reserve which recently kept its key rates unchanged. If that is the case, RBI's repo rate will stay at 6.5% for the fourth consecutive policy. Overall, India's central bank will be seen to have a 'wait and watch' approach.

In its latest report, CARE Ratings said that "The forthcoming Reserve Bank of India's (RBI) monetary policy committee (MPC) meeting, scheduled for the upcoming week, is set against a backdrop of growing domestic as well as external economic challenges."

Among the domestic challenges are growing risks to consumption demand amid soaring food inflation, an uneven monsoon adversely affecting kharif crops, higher interest rates and rising global crude oil prices.

The rating agency specifically pointed to consumer confidence which has witnessed a concerning decline with a notable drop of 1.5% in August, as per the CMIE's data.

In its note, CARE said, "The downside risks to consumption demand are further substantiated by the underwhelming sales performance of FMCG firms despite their increasing profitability. Nevertheless, the government's persistent commitment to capital expenditure is anticipated to support job creation and sustain economic momentum in the coming months. Additionally, the festive season is expected to bring about a seasonal uptick in consumption demand, even though downside risks to demand remain elevated."

According to CARE, recent developments suggest a potential rise in headwinds affecting consumption demand, particularly in rural areas. Hence, it is crucial to monitor emerging headwinds closely.

On the global front, CARE highlighted that the economic momentum remains ambivalent, with increasing anticipation of a 'soft-landing' for the US economy, while growth concerns remain elevated in Europe and China.

It pointed out that major central banks like the US Federal Reserve and European Central Bank (ECB) are expected to continue their borrowing costs higher for an extended period, thereby adversely impacting the capital flows into emerging markets.

Furthermore, crude oil prices have shot up rapidly to touch $95 per barrel last week, after the reduction in oil supply from OPEC member countries. Oil prices are expected to range between $90 to $100 per barrel in the current year, however, the likelihood of it crossing the $100 critical mark is not expected by many experts. But crude oil prices is expected by majority to pressurise inflation, and it is likely to be taken into consideration by RBI.

On soaring oil prices, CARE said, "This development has accentuated headwinds to the external economic scenario, as weakening global demand is poised to negatively affect domestic exports, while the import bill is expected to stay elevated due to higher energy costs."

Moreover, the country's current account deficit (CAD) is now projected to stand at 1.8% of GDP, higher than the prior estimate of 1.6% of GDP. CARE said, "The widening CAD and outflows of foreign portfolio investments have intensified depreciating pressures on the Indian rupee, resulting in a depreciation of approximately 0.5% in September."

In September month, the foreign portfolio investors (FPIs) pulled out up to $1.7 billion from the Indian market after being net buyers for six consecutive months prior. Apart from this, foreign exchange reserves have dipped to touch a nearly four-month low at $593 billion in the last week.

Despite the prevailing economic headwinds, for the October 2023 policy, CARE said, "We expect the RBI to retain its growth projections at 6.5% for FY24 as the RBI will likely adopt a 'wait and watch' approach, seeking better visibility on festive demand trends and estimates of kharif production before making any adjustments."

RBI is an inflation trajectory central bank and it is committed to bringing the consumer price index (CPI) to its tolerance limit of 2-6%. In August, CPI inflation cooled to 6.8% from a high of 7.4% in July, even though it continues to be above RBI's tolerance.

CARE believes food inflation will moderate going ahead with average inflation in the food basket slowing from 6.9% in Q2 to 5.6% in Q3 and 5.1% in Q4. Apart from this, the rating agency does not see the significant impact of the steep surge in global oil prices on India's retail inflation.

"As we approach the pre-election period, OMCs are expected to absorb a substantial portion of the increased global crude prices. The RBI is also likely to find comfort in the fact that the Wholesale Price Index (WPI) continues to remain in deflationary territory, and core inflation remains relatively benign. In August, core inflation moderated to 4.9%, down from 5.1% in July," CARE said.

Accordingly, CARE expects the September inflation print to remain above RBI's upper tolerance limit. As a result, it added that RBI will miss its Q2 inflation projections by ~60 bps and will consequently revise its whole-year projection to 5.6% from an earlier projection of 5.4%.

Some of the other key positives are -- GDP growth at 7.8% in Q1FY24, strong expansion in private consumption expenditure of 6%, and the upswing in consumption expenditure driven by increased discretionary spending by urban consumers, as reflected in healthy air and railway passenger traffic, growth in retail credit, and higher sales figures for passenger vehicles (PV).

Also, the government's emphasis on capital expenditure (capex) has supported investment activities and is corroborated by the robust growth in steel consumption, capital goods production, and cement production. Meanwhile, E-way bill collections which touched an all-time high of 93.4 million in August growing over 19% compared to the previous year, indicate buoyancy in economic activity, especially ahead of the festive season.

Also, the latest inclusion of Indian government securities in JP Morgan's bond index is a welcome move, although, its positive impact is expected to be gradual, as the weightage assigned to India will be increased incrementally over some time.

CARE also expects RBI to conduct liquidity management operations as and when required to support the money market conditions. Having said, that CARE expects the overall liquidity situation to remain tight.

In its concluding remark, CARE added, "Given the current circumstances, the RBI is likely to prioritise supporting economic growth, especially during the festive season, while remaining cautious on inflation. Therefore, we anticipate that the RBI will keep its policy rates unchanged, with a unanimous decision, while adhering to its stance of 'withdrawal of accommodation.' We do not anticipate any further rate hikes by the RBI in this fiscal year. The MPC is expected to consider rate cuts after the first quarter of the upcoming fiscal year."

At present, RBI's repo rate is at 6.5%, while the standing deposit facility (SDF) rate remains unchanged at 6.25%. Also, the marginal standing facility (MSF) rate and the Bank Rate is at 6.75%. The central bank expects CPI inflation at 5.4% for FY24, while GDP growth is seen at 6.5% for the current financial year.