Why the RBI Held Interest Rates Steady for the Ninth Time in a Row

 

The Reserve Bank of India (RBI) has once again decided to keep the repo rate steady at 6.5%, marking the ninth consecutive time it has left rates unchanged. This decision by the RBI’s Monetary Policy Committee (MPC) comes amid concerns over persistent food inflation, which continues to exert upward pressure on retail inflation. The MPC also maintained its stance on monetary policy as ‘withdrawal of accommodation’ during its meeting on August 8.

As a result of this decision, banks are likely to keep interest rates unchanged, meaning that borrowers can expect their existing EMIs to remain at current levels.

Despite ongoing inflationary pressures, the RBI has left its GDP growth projection for FY2025 unchanged at 7.2%, and its retail inflation forecast remains at 4.5%.

Reasons for Keeping the Policy Rate Unchanged

The six-member MPC voted by a 4-2 majority to retain the repo rate at 6.5%, the rate at which the RBI lends to banks for short-term needs. The committee has been increasingly concerned about elevated food inflation, which could disrupt the ongoing efforts to bring down inflation. In June, headline inflation, measured by the year-on-year (y-o-y) change in the all-India consumer price index (CPI), rose to 5.1% from 4.8% in May. The increase is largely driven by food inflation, which climbed to 8.4% in June from 7.9% the previous month.

"Food inflation remains stubborn and continues to contribute significantly to overall retail inflation," said RBI Governor Shaktikanta Das during a briefing on the policy decision. He emphasized the importance of maintaining price stability to achieve sustainable economic growth, noting that the MPC must remain vigilant to prevent any second-round effects from persistent food inflation.

Under the RBI's flexible inflation targeting framework, the central bank is tasked with keeping CPI within a 2-6% range, with a long-term goal of bringing it down to 4%.

Global investment firm Goldman Sachs noted that although a high base from the previous year might pull headline inflation down towards 4% in the third quarter, there are risks of food inflation persisting due to uneven monsoon patterns.

Shishir Baijal, Chairman and Managing Director of Knight Frank India, pointed out that while core inflation has eased to more manageable levels, volatile food prices continue to drive headline inflation higher. He also highlighted the potential for further inflationary pressures arising from geopolitical uncertainties, the depreciation of the rupee, and global economic fluctuations.

Impact on Lending Rates

With the repo rate remaining unchanged at 6.5%, external benchmark lending rates (EBLR), which are tied to the repo rate, will not increase. This provides some relief to borrowers, as their EMIs on home and personal loans will stay the same. However, lenders may still raise interest rates on loans linked to the marginal cost of fund-based lending rate (MCLR), where the full impact of the 250-basis-point repo rate hike between May 2022 and February 2023 has not yet been fully passed on.

In response to the cumulative 250-bps hike since May 2022, banks have revised their repo-linked EBLRs upwards. During the period from May 2022 to June 2024, the one-year median MCLR of banks increased by 168 bps. Additionally, deposit rates in certain categories may see a slight increase, as recent credit growth has lagged behind deposit growth.

When Could the RBI Cut the Repo Rate?

Some economists anticipate that the RBI could consider a rate cut as early as December 2024. The next MPC meeting is scheduled for October 7-9.

Bank of Baroda’s Economist Aditi Gupta suggested that December 2024 might be the earliest opportunity for a rate cut, depending on the RBI’s assessment of incoming data and prevailing economic conditions.

Aditi Nayar, Chief Economist and Head of Research and Outreach at ICRA, indicated that if food inflation eases due to a favorable monsoon and in the absence of significant domestic or global shocks, the RBI could change its stance in October 2024, followed by a potential 25-bps rate cut in both December 2024 and February 2025, with a longer pause thereafter.

HDFC Bank suggested that the current policy stance could be setting the stage for a rate cut later in the year, which could lead to a decline in bond yields, with the 10-year yield potentially moving towards 6.80%.

Influence of Global Events on India’s Policy

Recent global market movements have been influenced by several factors, including tensions in the Middle East, a surge in the Japanese yen, and growing concerns about a potential U.S. recession.

Expectations of a rate cut by the U.S. Federal Reserve have risen in recent weeks, with some analysts forecasting a 50-bps cut as early as September and cumulative cuts of 115 bps in 2024. If the Fed begins its rate cut cycle in September, delivering a 25-bps cut, this could have implications for the rupee and might prompt the RBI to align its monetary policy with global trends to avoid significant policy divergences.

An HSBC report noted that while its U.S. economists are not convinced that a recession is imminent, softening labor market conditions have increased the likelihood of further Fed rate cuts. HSBC expects three 25-bps cuts in 2024 and sees potential for an additional 75 bps of cuts in 2025.