Why the RBI Maintains Steady Repo Rates Despite Falling Inflation and Global Rate Cuts

The Reserve Bank of India (RBI) has once again opted to leave the repo rate unchanged at 6.5% for the 10th consecutive Monetary Policy Committee (MPC) review. This decision, announced after the MPC’s meeting from October 7-9, 2024, comes in the face of rising hopes for a rate cut, especially following rate reductions by the US Federal Reserve and inflation in India slipping below 4%.

Despite the growing optimism, the RBI cited persistent concerns over inflation, especially food prices, and geopolitical tensions as reasons for holding the rate steady. In a 5:1 majority decision, the RBI also chose to shift its monetary policy stance from “withdrawal of accommodation” to “neutral,” signaling a more balanced approach moving forward.

Why Did the RBI Keep Repo Rates Unchanged?

A key factor behind the RBI’s decision to maintain the repo rate is the ongoing volatility in inflation, particularly driven by rising food prices and geopolitical risks. September inflation was anticipated to rise sharply due to unfavorable base effects and increased food costs.

RBI Governor Shaktikanta Das emphasized that while headline inflation may moderate in the fourth quarter of FY2025, the risks posed by unexpected weather events and the potential impact of escalating geopolitical tensions in the Middle East—particularly between Israel and Iran—cannot be ignored. The conflict has the potential to push global oil prices higher, compounding inflationary pressures in India.

According to Suman Chowdhury, Executive Director & Chief Economist at Acuité Ratings & Research, the fear of inflation has not completely dissipated despite a recent cooling in CPI numbers. “Concerns around the stability of food inflation persist among policymakers,” he said, pointing out that recent retail price trends show rising vegetable prices.

Geopolitical Tensions and Domestic Indicators Weigh on Rate Decisions

The sudden intensification of the geopolitical conflict in West Asia, with the potential to disrupt oil supplies, has further complicated the RBI’s decision-making process. Oil price volatility could significantly impact inflation in India, which imports most of its crude oil.

Meanwhile, domestic indicators have also raised concerns. September’s Purchasing Managers’ Index (PMI) data showed a multi-month low, and core sector output contracted for the first time in 42 months. This suggests early signs of a broader economic slowdown, further muddying the outlook for interest rate adjustments.

Economists like Gaura Sen Gupta, Chief Economist at IDFC FIRST Bank, forecast that inflation in the near term could hover around 5% for Q3 FY2025. This aligns with the RBI’s cautious approach, focusing on both inflation control and economic stability.

Monetary Policy Stance Shifted to ‘Neutral’

One notable development from the recent MPC meeting was the change in the RBI’s monetary policy stance from “withdrawal of accommodation” to “neutral.” This shift indicates that the central bank will no longer take aggressive steps to tighten liquidity, offering more flexibility to respond to evolving economic conditions.

“The shift to a neutral stance is a sign of optimism for India’s inflation outlook, given easing food inflation and a favorable monsoon,” said Anu Aggarwal, Head of Corporate Banking at Kotak Mahindra Bank. She noted that this stance gives the RBI room to adapt to future developments, including potential shifts in global monetary policy.

Dhiraj Relli, MD & CEO of HDFC Securities, added that the shift also suggests the RBI is leaving the door open for a potential rate cut later in the fiscal year, should inflationary pressures ease further.

Inflation and GDP Projections Remain Steady

While there was speculation about potential revisions to the RBI’s inflation and GDP forecasts, the MPC chose to leave both projections unchanged. Retail inflation for FY2025 is still expected to average 4.5%, while GDP growth is projected to come in at 7.2%.

Das cautioned that while inflation might spike in the short term due to base effects and food price momentum, a good kharif harvest and ample buffer stocks of cereals should help mitigate inflationary pressures. However, he warned that geopolitical risks, particularly in oil markets, remain a significant concern.

GDP growth, meanwhile, continues to show resilience, although the first-quarter number of 6.7% was slightly lower due to a slowdown in government investment spending. Analysts expect growth to pick up in subsequent quarters as government capital expenditure resumes, supported by easing inflationary pressures.

Lending Rates and the Impact on Borrowers

Despite keeping the repo rate steady, borrowers can expect some relief in the near term as the external benchmark lending rates (EBLR), which are directly linked to the repo rate, will remain unchanged. This means equated monthly installments (EMIs) on loans tied to the EBLR will not increase.

However, for loans linked to the marginal cost of fund-based lending rate (MCLR), there is a possibility of lenders hiking rates. Full transmission of the 250-basis point increase in the repo rate between May 2022 and February 2023 has not yet occurred, meaning some banks may still adjust their MCLR-linked lending rates upward.

When Can Borrowers Expect a Rate Cut?

Looking ahead, some analysts remain hopeful that the RBI will deliver a repo rate cut as early as December 2024. If food inflation moderates and economic conditions improve, a shallow rate cut of 25 to 50 basis points could be on the cards, according to experts from CareEdge Ratings and HSBC.

HSBC forecasts a 25-basis point rate cut in both the December and February MPC meetings, which would bring the repo rate down to 6%. Bank of America is even more optimistic, predicting a 100-basis point cut by the end of 2025, starting in December 2024.

A Balanced Approach Amidst Uncertainty

The RBI’s decision to maintain the repo rate at 6.5% underscores its cautious approach in the face of a complex economic landscape. While inflation appears to be moderating, risks remain, particularly from global oil price volatility and domestic food inflation. The shift to a neutral stance, however, indicates that the central bank is preparing for more flexibility in its future policy decisions, leaving open the possibility of rate cuts later in the fiscal year.

For borrowers, the steady repo rate offers some short-term relief, though the prospect of future cuts hinges on further improvements in inflation and economic stability.