Tone change. As inflation moderates, RBI hits the pause button but changes stance to ‘neutral’

With the inflation closer to the 4 per cent target and growth sustaining its momentum, the RBI’s rate setting panel voted unanimously to change the monetary policy stance from “withdrawal of accommodation” to “neutral”, a move that was widely expected.

This action could be a precursor to a rate cut as early as in the December 2024 bi-monthly monetary policy review.

However, the six-member monetary policy committee (MPC), which has three new external members, chose by a majority of 5 out of 6 members to hold the policy repo rate steady at 6.50 per cent as the pace of disinflation has been slow and uneven. Only the newly appointed Nagesh Kumar voted to reduce the policy repo rate by 25 basis points.

The repo rate was last increased in February 2023 by 25 basis points to 6.50 per cent. It has been rock steady since then. The MPC had last changed its monetary policy stance to “to remain focused on withdrawal of accommodation” in its June 2022 meeting from its earlier “to remain accommodative while focusing on withdrawal of accommodation” stance.

Inflation is moderating

“We now have greater confidence that inflation is moderating, but we are acutely aware that there are significant risks. We changed the stance because we see that the balance between inflation and growth is well poised. So, the MPC considered it (the timing) appropriate to shift the stance to neutral (and to remain unambiguously focused on a durable alignment of inflation with the 4 per cent target, while supporting growth),” RBI Governor Shaktikanta Das said in his post monetary policy press conference.

He emphasised that this stance gives the MPC greater flexibility and optionality to act in sync with the evolving conditions and the outlook.

“Domestic growth has sustained its momentum, with private consumption and investment growing in tandem. Resilient growth gives us the space to focus on inflation so as to ensure its durable descent to the 4 per cent target. In these circumstances, the MPC decided to remain watchful of the evolving inflation outlook in the coming months. Keeping in view the prevailing inflation and growth conditions and the outlook, the MPC considered it appropriate to change the stance....,” Das said.

Disinflation slow and uneven

The Governor noted that headline (retail) inflation is on a downward trajectory, though its pace has been slow and uneven.

He cautioned that going forward, the moderation in headline inflation is expected to reverse in September and likely to remain elevated in the near-term due to adverse base effects, among other factors.

However, food inflation pressures could see some easing going into the third quarter on the back of strong kharif sowing, adequate buffer stocks and good soil moisture conditions which are conducive for rabi sowing.

Inflation horse

“It is with a lot of effort that the inflation horse has been brought to the stable — closer to the (4 per cent) target within the tolerance band (2-6 per cent) compared to its heightened levels two years ago.

“We have to be very careful about opening the gate as the horse may simply bolt again. We must keep the horse under tight leash, so that we do not lose control,” Das said.

Going forward, the MPC will closely monitor the evolving conditions for further confirmation of the disinflationary impulses.

Challa Sreenivasulu Setty, Chairman, State Bank of India, said: “The RBI’s policy statement is a clear recognition of robust growth and an inflation trajectory that is trending down. The shift in stance to neutral is an affirmative front loaded policy move that will ensure RBI remains nimble footed to align inflation with the 4 per cent target.”

Crisil Chief Economist Dharmakirti Joshi and Senior Economist Pankhuri Tandon observed that with the shift in stance, the MPC can change the repo rate in either direction in future, depending on economic data.

“That way, ‘neutral’ is less restrictive than ‘withdrawal of accommodation’, which would have signalled maintaining tight monetary conditions. Progress on disinflation and a good monsoon have encouraged the MPC to change tack.

“That said, a ‘neutral’ stance also affords the MPC the flexibility to respond to unexpected disruptions in the disinflation process from exogenous sources,” they said, adding the shift in the MPC’s policy stance is the first step of a policy pivot.

The credit rating agency’s Economists anticipate a 25-basis-point reduction in the repo rate during the MPC’s policy review meeting in December, given that food inflation is expected to ease after a healthy monsoon.