RBI Monetary Policy: What Lies Ahead? A Stance Change In October? Rate Cut In December?

The monetary policy committee expectedly decided to maintain status quo on the policy stance and rates in its third bi-monthly policy for financial year 2025, with a 4:2 vote on both. However, there were some surprises in the policy document, particularly in the tone, which was more hawkish than we had expected. For instance, the RBI governor clearly articulated that resilient and steady growth in the gross domestic product enables monetary policy to focus "unambiguously on inflation.".

On the inflation front, while the MPC kept its average consumer price index inflation projection for FY25 unchanged at 4.5%, it made several tweaks to its quarterly forecasts. It raised the Q2 FY25 projection quite sharply to 4.4% from 3.8% earlier, while cutting the Q4 FY25 estimate by 20 basis points to 4.3%. Additionally, it also issued a fresh estimate of 4.4% for Q1 FY26.

The policy document highlighted that the Q2 FY25 projections were revised upwards on account of a sharper uptick in price momentum relative to earlier expectations, which was likely to result in a shallower softening of the CPI headline inflation in the quarter. While we concur with the MPC's reasoning on this front, we expect the headline print to undershoot the committee's estimate in the quarter.

Overall, we expect the headline inflation print to average 4.6% in FY25, marginally higher than the MPC's estimate of 4.5% for the fiscal, amid expectations of mildly higher prints in the second half of FY25. We also concur with the MPC's assessment that core inflation has bottomed out and expect an uptick in core prints through the remaining part of the fiscal, led by various factors, including the recent telecom tariff hikes.

The committee cut its Q1 FY25 growth forecast marginally to 7.1% from 7.3% in the June 2024 policy meeting, while leaving the projections for Q2, Q3 and Q4 unchanged at 7.2%, 7.3% and 7.2%, respectively. It also issued fresh projections for Q1 FY26, expecting GDP growth to remain above the 7% mark in that quarter too.

We had expected the MPC to moderate its GDP growth forecasts for Q1 FY25 relatively more sharply vis-à-vis the 20-bps cut that it has instituted. The year-on-year growth in a majority of high-frequency indicators eased in that quarter vis-à-vis Q4 FY24, thereby pointing to a slowdown in volume growth. Additionally, there are visible signs of a tempering in investment activity amid slower YoY growth in most investment-related indicators vis-à-vis Q4 FY24 and a sharp YoY contraction in the Government of India's capex in that quarter owing to the general elections. Moreover, the benefits of deflation in commodity prices also receded in the quarter, which is partly reflected in the corporate results.

Given these factors, ICRA expects GVA growth to ease to sub-6% in Q1 FY25 from 6.3% in Q4 FY24. The unusually large wedge between the growth in the GVA and the GDP in Q4 FY24, which had resulted in a 7.8% growth in the latter in that quarter, is set to come off in Q1 FY25, amid a modest expansion in net indirect taxes as per the CGA data. Consequently, GDP growth is likely to see a significant deceleration in Q1 FY25 compared to Q4 FY24.

Likewise, we remain circumspect around the MPC's Q2 FY25 growth projection, which is above the 7% mark. Overall, we expect a transient slowdown in growth in H1 FY25, followed by a pickup to above the 7% mark in H2 FY25, aided by a back-ended government capital expenditure, some pickup in private capex, and an improvement in rural demand. As a result, we expect GDP growth to print at 6.8% in FY25, lower than the MPC's estimate of 7.2% for the fiscal.

What Lies Ahead?

On the domestic side, the Q1 FY25 GDP growth numbers will be released at the end of the current month. Our anticipation of an undershooting vis-a-vis the MPC's projection for the quarter may prompt the RBI to reassess its estimates for the growth trajectory and could also serve as a precursor to a stance change in October.

Additionally, the CPI inflation prints for July and August 2024 would be available before the next meeting. While any indications of an undershooting in the Q2 FY25 CPI estimate would bolster the case for a shift in the stance, developments on the monsoon front would be crucial. A commencement of the rate-cutting cycle in the US would also be keenly watched. Regardless, global risks abound, both related to politics and geopolitics.

Our assessment of the growth and inflation outlook suggests a stance change in the next policy meeting in October, followed by a shallow rate cut cycle of 50 bps over the December 2024 and February 2025 policy meetings. However, the surprisingly hawkish tone of the policy document leaves the door open for this timeline to be delayed, to a stance change in December 2024 followed by rate cuts in February and April 2025.

Aditi Nayar is the chief economist and head of research & outreach at ICRA.

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