By Indranil Pan, Chief Economist at Yes Bank

Expected by some and not expected by others – RBI’s newest MPC (Monetary Policy Committee) was unanimous in changing the stance of the monetary policy to “neutral” from “withdrawal of accommodation”. While doing this, however, the hawk continues to remain firmly perched at its vantage point and is looking squarely at inflation. Thus, the RBI points out that it remains “unambiguously focused” to align inflation to the target of 4 percent.

Interestingly, the elephant simile of inflation has now been changed to a horse. While at the press conference, the RBI governor indicated that there is no reason for doing so, what could have been playing in his mind is that risks for inflation being at the upper end of the tolerance band or beyond that is now low – hence the “inflation” is not an “elephant”. It might now have transformed into a “horse” because if the gatekeeper of the stable were to be complacent, the horse will bolt off very fast.

Important to understand is what could have changed between August and now that warranted a change in the stance. First, inflation has continuously been on a downward trend and more importantly food inflation. Remember we had articles from the RBI that went into depth of explaining how food inflation has been sticky and adamant, subject to repeated adverse shocks etc. The context being made here is that there is now a better confidence that upside supply-driven risks to food inflation could be lower. This is due to the great southwest monsoons that the country has had, not only in terms of precipitation but also in terms of spatial distribution. Reservoir levels as also soil moisture levels are good now, a great enabler for the rabi sowing too. Kharif sowing is better than last year, and the nation looks forward to a great harvest season ahead, implying good buffer stock levels.

Over a long period, when inflation risks had persisted, the RBI had shied away from providing any forward guidance. Now, when inflation risks are fading, and growth-inflation is coming in better balance, this was a good opportunity for the RBI to have signaled that one might soon be able to look forward to easing rates in the system. The RBI had also harped for long on the insufficient transmission of monetary policy. But now with credit growth slowing, especially to the hitherto risky areas of personal loans, there is now a satisfaction on the transmission to the credit markets. And forward-looking surveys are providing comfort. For instance, unlike higher moves in the previous round of survey, the September 2024 round of household inflation expectations survey show easing of 3-month and 1-year ahead median inflation expectations by 20 and 10 bps respectively. Manufacturing firms polled in the July - September 2024 round of the RBI’s industrial outlook survey expect pressures from cost of raw materials to continue but show some softening. Services sector companies and infrastructure firms still see input cost pressures persisting but selling prices growth to moderate in Q3FY25.

The critical question remains why the RBI did not cut rates in this policy. First, the RBI acknowledges that inflation print for September to November will stay on the higher side (our estimates indicate a range of 5.0-5.2 percent), on the back of adverse base from last year and would want to see off this hump. Further, the early indications for October are that vegetable prices in the first 8 days of the month have risen by 11 percent while edible oil prices are up by 6.1 percent. For FY26, assuming a normal monsoon, RBI projects Headline CPI to average at 4.1 percent, down from 4.5 percent expected in FY25. However, the global conditions remain fraught with risks emanating from geopolitical issues and war that has led to a pickup in the Brent crude oil prices to US$ 78-80 per barrel.

FAO (Food and Agriculture Organization) food price index has shown an uptick in global food prices in August. Though the outlook for rabi sowing and kharif harvesting remains favourable, any adverse weather events could disturb the food inflation trajectory. A pickup in commodity prices on account of China stimulus and geopolitical tensions could lead to higher input cost pressure for the manufactures and it needs to be seen if there is any pass-through with domestic demand remaining robust.

So, where does this leave us? The external members are new and the minutes of the meeting to be brought out on October 23 will provide better clarity. It would also be important to understand the minds of the internal members that could have led to the change in the stance. A shift to a neutral stance surely provides “greater flexibility and optionality” to the RBI to react to evolving conditions. Watchfulness on inflation is warranted as has been explained by the RBI. Every policy becomes live from now on though there is still no guarantee for a December cut. While the start date of a rate cut is debated, there appears little debate on the fact that the depth of the rate cut this time will remain shallow – only to the extent of 50-75 bps.

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