MPC's December Policy Meeting: Balancing Growth Pressures and Inflation Concerns

 The Monetary Policy Committee (MPC) had shifted its stance to neutral in its October meeting, moving away from "withdrawal of accommodation" but maintaining a hawkish tone on inflation. Despite no indication of imminent rate cuts, the MPC projected confidence in growth while acknowledging that inflation remained above the 4% target. However, since then, significant global and domestic developments have created new possibilities for the upcoming MPC meeting this Friday.

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Global Developments

1. US Election Outcome:

   • The recent US elections have led to market volatility, with concerns about tariffs, fiscal expansion, and immigration policies potentially fueling inflation in the US.
   • US Treasury yields (USTs) initially spiked sharply but have since cooled by 20–25 basis points.
   • The dollar index (DXY) has strengthened, pressuring major and emerging market currencies.

2. Crude Oil Prices:

   • Brent crude prices have moderated to $72–73 per barrel, down from $77–80, as Middle East tensions ease.

3. Global Central Bank Actions:

   • Despite uncertainties, central banks in the US, UK, and Sweden have continued rate cuts to support growth.
   • South Korea’s central bank delivered a surprise rate cut to boost domestic growth.

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Domestic Developments

1. Inflation:

   • October inflation came in higher than expected at 6.2%, driven by food prices, especially vegetables, while core inflation remained below 4%.
   • November inflation is expected to range between 5.5% and 5.7%, keeping inflationary concerns alive.

2. Currency and Liquidity:

   • The INR has touched a record low of 84.69 against the USD, despite being one of the better-performing currencies this year.
   • Banking liquidity has tightened due to the RBI’s FX interventions (selling dollars to curb INR volatility) and GST outflows. While liquidity may improve in December with government spending, a tight or deficit scenario could persist in the medium term.

3. Growth Concerns:

   • The Q2 FY25 GDP growth surprised negatively at 5.4%, significantly below expectations, raising concerns about the growth trajectory.
   • Credit growth has moderated, and deposit growth has surpassed credit growth for the first time in two years.
   • Foreign Portfolio Investors (FPIs) have been net sellers, offloading ₹1.1 lakh crore in equities and ₹9,000 crore in debt in October and November. However, since late November, FPIs have turned net buyers in G-Secs, purchasing ₹7,000 crore.

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MPC’s December Policy Dilemma

1. Inflation Focus vs. Growth Support:

   • Inflation remains above the comfort zone, but the sharp slowdown in growth could push the MPC to shift its focus towards growth support.
   • This would align with global trends, where central banks have prioritized growth despite headline inflation being above targets.

2. Liquidity Challenges:

   • Persistent liquidity tightness may prompt the RBI to consider measures like a 25 bps Cash Reserve Ratio (CRR) cut.
   • The current CRR of 4.5% is higher than the pre-pandemic level of 4%, making a cut justified under liquidity management objectives.

3. Policy Messaging:

   • The MPC’s communication on the inflation-growth balance will be crucial. A shift in narrative could signal a pivot toward accommodative measures in the near term.

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Our Expectations for the Policy Outcome

1. Rate Action:

   • While a rate cut in December seems unlikely, the MPC could prepare the groundwork for a February 2025 cut.
   • A split in voting (as opposed to the 5:1 in the last meeting) could signal the shift.

2. Liquidity Measures:

   • To ensure effective rate cut transmission, the RBI might focus on aligning overnight rates with policy rates.
   • Between Open Market Operations (OMO) and a CRR cut, a CRR cut seems more likely, aligning with pre-pandemic norms.

3. Growth-Inclusive Messaging:

   • The MPC may emphasize growth concerns, especially in light of subdued government capex and sluggish private capex.

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Conclusion: A Potentially Pivotal Meeting

This meeting could be a turning point for monetary policy. While the MPC might maintain a status quo on rates, its tone and messaging could set the stage for rate cuts in early 2025. By then, inflation projections for FY26 may align closer to the 4% target, providing room for easing measures. A decisive move on liquidity, such as a CRR cut, could also support market sentiment.

Overall, this policy meeting is likely to be closely watched for its guidance on managing inflation, growth, and liquidity challenges in a dynamic economic environment.