Although the central bank has been given some room to pursue another rate cut at this week’s meeting, the rate-setting committee is more likely to keep monetary policy at the current level.
Given the significant reduction in the policy rate last November, when it set the overnight policy rate (OPR) at 8.00 percent, First Capital Research (FCR) said.
A few days before the policy meeting, the FCR, releasing its traditional pre-policy analysis for the first time in the year, assigned an 80 percent probability to the Monetary Policy Committee to keep the newly introduced OPR at its current level, taking into account developments in the broader economy that are responding to the easing monetary policy.
It also expects the reserve ratio of banks to remain at its current level of 2.0 percent.
The FCR cited the fact that the economy is firing on almost all cylinders, as indicated by the continuously improving purchasing managers’ index data for manufacturing, services and construction. This was further supported by the robust economic growth of 5.5 percent in the third quarter.
Both estimates and anecdotal evidence suggest that the economy has performed even better in the last three months of last year, supported by low rates, post-election euphoria and year-end festive demand amid deflationary conditions.
The FCR highlighted the increasing demand for personal credit, which reached a low of Rs 100.0 billion in November 2024, and comfortably high money market liquidity conditions as reasons for the rate-setting committee to refrain from further rate cuts. The current near five-year high in business confidence will indicate to the MPC that the current policy stance is at the right level, ensuring that the economy is neither overheating nor slowing down. In a recent report on the long-term deviation from the quarterly inflation target, the central bank said it expects its negative annual inflation to end in the second quarter of this year and converge to its 5.0 percent target by the third quarter. Consumer price indices showed that monthly food prices have risen faster than non-food prices in recent months, and deflationary pressures are gradually abating.
The recent reduction in electricity tariffs by an average of 20 percent may further help to keep prices low.
The FCR warned against further easing of monetary policy that could erode the gains made so far in the external sector. With the resumption of loan repayments, imports, especially auto imports, will reopen, the FCR said.
This could weaken the rupee against the dollar and make it harder for the central bank to raise dollars to rebuild foreign exchange reserves, which has so far increased the resilience of the external sector. Low borrowing rates created demand for loans, which in turn led to an appreciation of the dollar through the need for more imports.
“A stable interest rate policy would help balance the demands of loan repayments, reserve building and import financing without undermining fiscal and monetary stability,” the FCR added.
