The Growth-Inflation Tug of War: RBI’s 2025 Policy Outlook with a New Governor
The Reserve Bank of India's (RBI) Monetary Policy Committee (MPC) is currently navigating a complex economic landscape marked by rising inflation and sluggish growth. The recent appointment of Sanjay Malhotra as the new RBI Governor adds another layer of intrigue to the central bank's policy direction. Malhotra, who took charge on December 11, 2024, previously served as the Revenue Secretary in the Ministry of Finance, and this will likely see the MPC tilt to the dovish side.
In its latest meeting held from December 4 to 6, 2024, the MPC opted to maintain the repo rate at 6.5%, marking the eleventh consecutive pause since it was last adjusted. This decision reflects a cautious approach amid rising inflation, which surged to 6.2% in October, exceeding the RBI's comfort zone of 2-6%. At the time, the committee's decision to cut the cash reserve ratio (CRR) by 50 basis points indicates a willingness to inject liquidity into the economy, a traditionally dovish manoeuvre aimed at stimulating growth, and setting a stage for rate cut.
Malhotra's appointment comes at a crucial time when there is increasing pressure from the government to consider cutting interest rates to support economic growth, particularly following disappointing GDP figures. His background in the Ministry of Finance suggests a potential alignment with fiscal policies that favour lower rates.
The prospect of interest rate cuts appears increasingly plausible as economic conditions evolve. If inflation continues to moderate in December and January, the RBI may begin to lower rates in its February 2025 meeting. Concerns regarding inflation remain paramount for the RBI though. The central bank has indicated that while it is monitoring inflation closely, any decision to cut rates will be heavily data-dependent. The recent upward revisions of CPI forecasts for upcoming quarters suggest that while inflation may be stabilising, it is still a significant concern that could delay any potential easing of monetary policy. Meanwhile, the growth-inflation dynamics present a challenging scenario for the RBI. GDP growth has slowed to 5.4% for the July-September quarter, raising alarms about economic momentum. The MPC's discussions highlighted concerns over sluggish government spending and its impact on overall economic activity. Further, the NSO’s latest sharp downward revision of real GDP growth in FY25 to 6.3% (from 8.2%) will weigh drastically on the central decision.
Adding to the concerns, the Indian rupee has faced significant pressure, recently hitting an all-time low against the US dollar. This depreciation raises concerns about imported inflation, particularly given India's reliance on foreign goods and energy. A weaker rupee could exacerbate inflationary pressures, complicating the RBI's task of maintaining price stability while supporting growth.
Looking ahead, we anticipate that if inflation stabilises around the RBI's target range, there could be room for three rate cuts in 2025. However, this will largely depend on external factors such as global commodity prices and domestic supply chain disruptions that could exacerbate inflationary pressures. As the MPC prepares for its next meeting scheduled for February 2025, all eyes will be on how Malhotra navigates this delicate balance amid evolving economic conditions.