RBI monetary policy: Status quo likely as slim Modi win fans fear of fiscal populism

RBI MPC meeting: The central bank is likely to keep interest rates steady amid concerns of fiscal populism following a weak election outcome for Prime Minister Narendra Modi.

The RBI is anticipated to hold the benchmark rate at 6.5% for the eighth consecutive meeting today.  Market experts anticipate the RBI to begin rate cuts only in the third or fourth quarter of FY25. The June MPC meeting will be crucial for insights into the RBI Governor's views on inflation and the future rate cut trajectory.

Economists warn that the BJP-led NDA government might increase welfare spending to regain support, potentially driving inflation above the RBI's target. Citigroup economists Samiran Chakraborty and Baqar Murtaza Zaidi suggest that the central bank will closely monitor the fiscal outcomes of the upcoming budget before making any policy changes. Maintaining the status quo in June’s policy is likely, with a focus on reducing volatility.

Economists had already delayed their rate cut forecasts, predicting the RBI would wait for the US Federal Reserve to pivot. Traders will be keen to hear Governor Shaktikanta Das’ views on the new government's fiscal policy in the upcoming budget. 

The RBI’s substantial dividend to the government provides some fiscal cushion.

Attention will also be on the RBI’s comments regarding system liquidity ahead of India’s inclusion in JPMorgan Chase & Co.’s bond index.

Expected announcements from Das include:

Growth and Inflation:

The RBI is likely to stick to its projections of 7% GDP growth and 4.5% average inflation for the fiscal year ending March 2025. Das has indicated that rate changes will not occur until inflation stabilizes around the 4% target. With April’s inflation at 4.83% and the previous fiscal year’s growth exceeding 8%, there is room to keep rates higher.

Goldman Sachs has postponed its rate cut prediction to the year-end, while Morgan Stanley and MUFG Bank foresee no changes until 2025, allowing the RBI to watch for policy shifts and monitor the monsoon and the Fed’s rate decisions.

Policy Stance:

The RBI has maintained a “withdrawal of accommodation” stance since June 2022, and this is unlikely to change soon. Economists believe maintaining this stance signals no immediate rate cuts are planned.

Bonds and Liquidity:

India’s inclusion in the bond index highlights the RBI’s liquidity management. While keeping cash conditions tight to aid rate transmission, incoming bond flows will pose a challenge. The RBI may use reverse repo auctions and sell-buy swaps to manage excess liquidity.