The monetary policy committee (MPC) of the Reserve Bank of India (RBI) is likely to maintain a status quo on key rates in the upcoming policy review, notwithstanding the expected benign consumer price inflation of 4.5 per cent for FY2025. The committee would likely assess the progress of the monsoon as well as the Union Budget for FY2025 presented by the new government before embarking on rate cuts. The impact of capital flows on the inclusion of Indian government bonds (IGBs) in global bond indices in June would also be closely watched. Additionally, the strong credit growth in the banking sector and persistent liquidity deficit poses a challenge in undertaking rate cuts in the near term.

With an all-time high incremental bank credit of ₹22.3 lakh crore during FY2024, the credit-to-deposit ratio for banks, too, neared an all-time high of 78 per cent as of March 2024. High credit growth in the banking sector, in relation to deposits growth, keeps upward pressure on deposit rates and tightens systemic liquidity; this could go contrary to the MPC’s decision for a rate cut. With a seasonally slack month for credit demand, the daily average liquidity deficit and overnight interest rates have cooled to ₹1.2 lakh crore and 6.51 per cent, respectively, till May 13, from the peak of ₹2.1 lakh crore and 6.68 per cent, respectively, in January. 

During FY2024, deposit growth was supported by the withdrawal of the ₹2,000 note and partly by strong capital inflows, which aided the liquidity of the banking system. FY2025 holds the promise of robust capital inflows from the inclusion of IGBs in global bond indices, which may lend some stability to the forex reserve and the exchange rate while assuaging the liquidity-related concerns, if any, of the RBI and the MPC.

Some of the RBI’s recent moves were meant to moderate the credit growth of banks. This may give the RBI and MPC some headroom to undertake a rate cut, while limiting the need for regular liquidity infusion to keep overnight rates close to policy rates. We believe that the RBI and the government are acting jointly to manage the systemic liquidity position. The government’s recent move to buy back near-maturity IGBs to address liquidity needs amid the ongoing general elections and, consequently, a curtailed government spending, may also be seen as a well-planned, coordinated action.

Election impact

Despite sizeable policy rate hikes over the last two years, credit growth has largely remained immune, driven by strong growth in direct and indirect (through non-banking financial companies or NBFCs) retail credit. While consumption demand has remained robust, investment demand from the corporate sector remains muted. If the election outcome brings more certainty to the investment plans of the corporate sector, the interest rates must help bolster this demand. This could also mean driving a better balance between demand from the corporate and retail sectors. Notwithstanding the concerns over high credit growth, the regulator may continue to announce policy actions to channelise or slow down credit to select sectors, apart from just the interest rates.

Lastly, in our globalised world, as we get more integrated with other economies, the actions by other central banks will continue to influence domestic policymaking. Inflation in various developed economies remains sticky, driving uncertainty on the quantum as well as the timing of rate cuts. Nonetheless, the expectations of rate cuts in many developed economies during the current year will provide a window to the MPC to embark on a rate cut path, if the domestic inflation-growth dynamics remain supportive. However, we expect the MPC to pivot on this rate cycle only when there is certainty in the direction of global rates. Till then, the action may remain outside the policy dates. 

(The writer is Senior Vice President and Group Head, Financial Sector Ratings, ICRA)