RBI data shows that on average, the weighted average term deposit of banks has come down by more than 100 bps on fresh deposits since Jan

The next big announcement on the anvil is the credit policy. It comes at interesting times, as there is more clarity on the way forward for the economy, notwithstanding the uncertainty on the tariff issue. India is now close to signing a deal with the USA which will definitely add further momentum to the economy. 

Monetary policy these days looks at both growth and inflation. Growth is poised to be around 7% this year or even higher. This is driven by the domestic factor where the countervailing measures invoked by the government in the form of GST rationalisation have helped to clear the deck.

Consumption has picked up, and it is expected that investment, too, will increase with a lag, as higher consumption leads to better capacity utilisation and, hence, capital formation. If consumption is sustained going ahead, then there is reason for one to be optimistic about 7% plus growth in FY27 too. Hence, there is no concern on the growth front. 

Inflation has been surprisingly on the downside, and it does look like it will average less than the RBI forecast of 2.6% and could go to 2.4-2.5%. Food prices are benign, and the expected good rabi crop will supplement the kharif crop and keep prices subdued.

There is, of course, the base effect, which has kept food inflation in the negative territory. The reduction in GST rates across a series of manufactured goods would play out in the coming months and ensure that core inflation too moderates to levels of less than 4%. Therefore, the number is more of academic interest when it comes to policy.

The monetary policy is always forward-looking, and, hence, inflation in the future is important when it comes to setting rates. Here, it does look like inflation will be in the range of 4-4.5% next year based purely on the base effect. With inflation being less than 1% for a series of months (which is likely in November and December too), there will tend to be a bump-up in inflation next year. Therefore, we need to work on future inflation rather than contemporary inflation. 

If inflation were to be range-bound in the 4-4.5% bracket, then the real repo rate would be in the range of 1-1.5%, which is something necessary to ensure that savers get a fair return. This number of 1-1.5% is not sacrosanct. RBI studies in the past have shown that the range of 1.4-1.9% should be the ideal real repo rate. Going by this logic, the repo rate of 5.5% looks fair. In fact, the average repo rate since 2011-12 (which is when the CPI index was reckoned) has been 6.35%. Therefore, the rate at 5.5% appears to be well balanced given that inflation has come down to a low in the last couple of months and will stay in this domain for a few more months. 

The other interesting observation is that while the repo rate has come down by 100 bps since February, the impact on credit growth has been slow. This is because interest rates are not the sole determining factor for higher offtake in credit. In fact, investment is linked more to capacity utilisation, which in turn is dependent on consumption.

The present spurt in consumption, witnessed post GST rationalisation, has increased demand, which is a necessary condition for investment to take place. Therefore, interest cost is not the limiting case when it comes to corporate investment. Interest costs are, however, important for MSMEs, as they operate on a smaller scale and are dependent on banks for working capital. Lower rates do help them in terms of lowering the overall cost of production. 

Taking a call on interest rates at this juncture is interesting because the savings side is rarely an important component of the discourse. It has been seen today that there has been migration of funds from banks to mutual funds, as interest rates have come down. The RBI data shows that on average, the weighted average term deposit of banks has come down by more than 100 bps on fresh deposits since January.

This is an encouraging sign from the point of view of rate transmission. However, simultaneously, the increase in assets under management of mutual funds has risen by Rs 14.4 lakh crore in the 7-month period compared with Rs 16 lakh crore in deposits. Clearly, savers are looking for better returns from the market. Lowering the rates at this stage would only mean challenges on the deposits side.

The broader question on monetary policy is that if not this time, will there be a rate cut in the future? This is again a view which must be taken by the committee. There is a view that the rate cycle has ended and there should logically be no more rate cuts if the equilibrium real rate has to be maintained in the future. Besides, a 25 bps cut will not really make much difference to growth per se, which will be driven more by the outcome of the tariff issue, which is linked inexorably to private sector investment. 

Speculation on interest rates has increased ever since the inflation rate has come down to new low levels. In the current financial year, there has been the tendency for the inflation rate to decrease continuously from 3.3% in March to 1.6% in July, when there was an aberration at 2.1% in August. Subsequently, it fell sharply to 0.3% in October. These rather unusual conditions have led to this debate on inflation, as it is likely to also be less than 1% in the coming months. This is also why perspectives of future inflation become important as well as the real interest rate, as the present is driven a lot by statistical effects due to higher inflation in 2003 and 2024.