Monetary Policy: RBI cuts repo rate, charts out path for the future

Finally, the Reserve Bank of India (RBI) has kicked off an easy-money policy regime. 

At the end of the three-day meeting of its rate-setting body, the monetary policy committee (MPC) — the first in 2025-26 (FY26) — the Indian central bank on Wednesday reduced the policy repo rate by 25 basis points (bps) to 6 per cent. One basis point is a hundredth of a percentage point. 

This was the second successive rate cut since February. More important than the rate cut is the change in the monetary policy stance – from ‘neutral’ to ‘accommodative’. Both decisions of the six-member MPC were unanimous. 

RBI Governor Sanjay Malhotra’s statement explains what an accommodative monetary policy stance means: It is geared towards stimulating the economy through softer interest rates. This implies more rate cuts will follow. 

The stance change forced the community of analysts to rush to the drawing board and change their take on the terminal interest rate. From 5.5 per cent to 5.75 per cent, it is now down to 5.25 per cent to 5.5 per cent. A series of rate cuts might cumulatively reduce the rate by 50-75 bps during the current financial year. 

For the record, the last time the RBI had changed its monetary policy stance from ‘neutral’ to ‘accommodative’ was in June 2019, when it had cut the repo rate by 25 bps to 5.75 per cent in order to support economic growth amid concerns of a slowdown and benign inflation. This had been after maintaining a ‘neutral’ stance since February 2017. 

In October 2024, the RBI had shifted its policy stance from ‘withdrawal of accommodation’ to ‘neutral’ while keeping the repo rate unchanged at 6.5 per cent, signalling potential rate cuts in the near future to support growth. The first rate cut in the current cycle – the first since May 2020 — was announced in February. 

While the rate cut was widely expected, there was no consensus among economists on the policy stance change, given global uncertainties amid US President Donald Trump waging a trade war. Why has the RBI done this? It’s fairly simple. The growth-inflation dynamics have changed. Inflation is tame and so are growth impulses in the economy. So, the Indian central bank is ready to give a push to non-inflationary growth by cutting the policy rate now and in the near future. 

It has lowered its real gross domestic product (GDP) growth estimate for FY26 by 20 bps from the February estimate to 6.5 per cent. Quarter-wise, real GDP is expected to grow 6.5 per cent in the first quarter, 6.7 per cent in the second, 6.6 per cent in the third, and 6.3 per cent in the fourth. The risks are evenly balanced. 

The RBI has also reduced its consumer price index (CPI) -based inflation estimate for the year. Even though non-food, non-oil, core inflation inched up in February, a combination of benign food inflation, a drop in global crude prices, and the assumption of a normal monsoon, has encouraged the central bank to project CPI-based inflation at 4 per cent in FY26. This is the middle point of the RBI’s inflation target – 4 per cent with a band of 2 percentage points on either side. 

Going by the projection, CPI-based inflation will be well below the RBI target of 4 per cent in the first three quarters of the year — 3.6 per cent, 3.9 per cent and 3.8 per cent, respectively. This means the real interest rate, assuming the policy rate as the benchmark, will be more than 2 per cent going forward (6 per cent minus inflation). This fuels the expectation of a series of rate cuts, bringing the repo rate down to 5.25-5.5 per cent.

 

While the ideal policy rate is in the realm of speculation for now, the message from the Indian central bank to the market, banking and corporate sectors is crystal clear. From now on, the rates can only go down and, in the easing cycle, the liquidity will be sufficiently in surplus. It wants to give growth a boost by bringing down the cost of borrowings. This will definitely help policy rate transmission. 

The yield on the 10-year government bond closed at 6.44 per cent on Wednesday, compared to 6.47 per cent the previous day. Immediately after the rate-cut announcement, it rose to 6.54 per cent, but dropped once the market learnt of the stance change. The rupee closed at 86.68 a dollar, down from 86.25 the previous day. 

One way of looking at the change in the policy stance could be India joining China and a few other nations for competitive devaluation of their local currencies as the trade war escalates. I don’t agree with this theory. But it is a fact that protection of the rupee’s value is not high on the RBI’s agenda at present. Supporting growth is its main objective. For that, the policy rate will be reduced further. In the process, if the rupee depreciates, so be it. 

Despite the rate cut and the policy stance change, stock market indices dropped and bank stocks tumbled on Wednesday. There are reasons behind this. First, the concern of an economic slowdown is official now. In fact, most economists feel the RBI’s growth projection of 6.5 per cent for FY26 is rather optimistic. When growth is muted, the stock market cannot be euphoric. 

And, banks will have a challenging time. With the policy rate going down, the loan rate for a sizeable chunk of their portfolio will have to be pared, as these are linked to an external benchmark like the repo rate or the treasury bill yield. Will they be able to bring down their deposit rates to that extent? Probably not. This means their net interest margins, loosely the difference between what they pay to depositors and what they earn from borrowers, will shrink. They need to buckle up to negotiate the new road ahead. 

The writer is an author and senior advisor to Jana Small Finance Bank Ltd. His latest book: Roller Coaster: An Affair with Banking. To read his previous columns, please log on to www.bankerstrust.in. X: @TamalBandyo