The Reserve Bank of India (RBI) in its Monetary Policy Committee (MPC) meeting yesterday announced a significant shift in its policy stance from "withdrawal of accommodation" to "neutral" with unanimous support. The repo rate was kept unchanged by a 5:1 majority, marking a cautious approach toward inflation management and growth outlook. This MPC was the first to include three new external members, adding fresh perspectives to the committee's deliberations.
Inflation: From 'Arjuna's Eye' to 'Horse Back in the Stable'
The RBI's decision to change its stance reflects growing confidence among its members regarding the inflation trajectory. While inflation has been a persistent concern, the central bank now sees it as more stable, though it remains cautious. Governor Shaktikanta Das, who had previously likened inflation to an "elephant in the forest," described it as a "horse back in the stable" in this policy meeting. However, he added a note of caution: "We have to be very careful about opening the gate, as the horse (read inflation) may simply bolt again." This sentiment suggests that the MPC is keeping its options open, particularly if inflation stays around 5% in the coming months or if global economic conditions shift.
By adopting a neutral stance, the MPC gains flexibility. It can now decide to cut, hold, or hike rates based on evolving economic conditions, including domestic inflation trends and global factors. This optionality will be crucial as the RBI navigates future policy decisions.
Macro Forecast: Growth and Inflation
The MPC revised its growth forecast for Q2 FY25 downward from 7.2% to 7.0%, while maintaining the full-year GDP forecast at 7.2%. A better-than-expected monsoon has raised hopes for keeping inflation in check, though a rise in inflation is expected in Q3 FY25 due to base effects. Key indicators from the last six MPC meetings highlight the evolving economic conditions and forecasts.
Rural Demand: A Positive Outlook
Rural demand has shown signs of improvement, with two-wheeler (2W) sales rising 10.7% year-over-year in July-August 2024. Additionally, demand for jobs under the Mahatma Gandhi National Rural Employment Guarantee Act (MNREGA) fell by 16.6% during Q2 FY25, indicating improved farm employment. Fast-moving consumer goods (FMCG) sales volumes in rural India have outpaced urban areas since Q4 FY24, further pointing to strengthening rural consumption.
Global Economic Growth: Resilient but Cautious
Globally, the economy has remained resilient despite ongoing risks such as geopolitical conflicts, financial market volatility, and elevated public debt. Inflationary pressures have softened, mainly due to declining energy prices. India's economy continues to grow steadily, driven by robust performance in agriculture, manufacturing, and services sectors. A strong monsoon has supported agricultural growth, while manufacturing is benefiting from rising domestic demand, lower input costs, and favorable policies. India's services sector remains in expansion mode, with the Services PMI showing consistent growth globally for 20 consecutive months.
Domestic Liquidity: Banking Sector Developments
India's banking system liquidity remains in surplus due to government spending on capital expenditure and subsidies following the Lok Sabha elections. Despite this surplus, certificate of deposit (CD) rates have risen as banks seek to meet high demand amidst slower deposit growth. The RBI has expressed concerns about unchecked growth in non-banking financial companies (NBFCs), particularly in unsecured loans and microfinance institutions (MFIs). The central bank hinted at potential regulatory actions if this trend continues unchecked.
Key Retail Measures Announced
The RBI also announced two important measures for retail consumers:
- The introduction of a beneficiary account name verification facility for NEFT/RTGS transactions, similar to the existing UPI payment system.
- An increase in transaction limits for UPI123Pay (from ₹5,000 to ₹10,000) and UPI Lite wallet (from ₹2,000 to ₹5,000, with the per-transaction limit raised from ₹500 to ₹1,000).
Market Impact: Bonds and Interest Rate Swaps
While government securities (G-sec) and Overnight Indexed Swap (OIS) markets initially saw significant spread corrections, yields quickly recovered. The 10-year G-sec yield only corrected by 4 basis points (bps) after an 8 bps intraday drop, and the 5-year OIS closed just 1 bps lower at 6.12%. The cautious tone from Governor Das regarding rate cuts—emphasizing the need for careful consideration—kept expectations for a December rate cut muted.
Outlook: Cautious Optimism
While the shift to a neutral stance opens the door for potential rate cuts, the detailed focus on inflation risks suggests that any cuts will be gradual and dependent on data. Governor Das’ cautious remarks—particularly the analogy about inflation being a "horse in the stable"—suggest that a December rate cut is not the base case. The MPC will continue to prioritize inflation control, but if growth falters, as some forecasts suggest, the focus may shift toward stimulating economic activity. For now, the most likely timeline for a rate cut remains February or April 2024.
India's Sovereign Bond Inclusion in FTSE Index from September 2025
In a significant development, FTSE Russell reclassified India’s Market Accessibility Level (MAL) from 0 to 1, paving the way for the inclusion of Indian Government Bonds (IGBs) in the FTSE Emerging Markets Government Bond Index (EMGBI) starting in September 2025. Over a six-month period, India’s weight in the index is expected to reach 9.35%.
This inclusion is anticipated to bring inflows of approximately $489 billion, with monthly inflows of around $81.5 billion between September 2025 and March 2026. This move completes India’s inclusion in the three major global emerging market bond indices and is expected to boost liquidity and lower funding costs across the yield curve, including corporate bonds.
The structural impact of this inclusion is positive, adding credibility for foreign portfolio investors (FPIs) and further enhancing the ownership base of government securities (G-secs). This may also pave the way for India’s inclusion in the Bloomberg Global Aggregate Index, further solidifying its position in the global financial markets.
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