RBI Cuts Rates After 5 Years, Shifting Focus from Inflation to Growth

The Reserve Bank of India (RBI) cut the repo rate by 25 basis points to 6.25%, marking its first reduction in five years to boost economic growth. Governor Sanjay Malhotra signaled a shift towards a more accommodative policy, aligning with fiscal measures like recent tax cuts. While inflation is expected to ease to 4.2% in FY26, global economic risks and financial market volatility remain key concerns.

CONTENTS:

• RBI’s Policy Shift: First Interest Rate Cut in Five Years
• RBI Prioritizes Growth Over Inflation with Interest Rate Cut
• RBI Cuts Repo Rate but Warns of Global Growth Challenges

RBI Cuts Rates After 5 Years, Shifting Focus from Inflation to Growth

RBI’s Policy Shift: First Interest Rate Cut in Five Years

RBI Cuts Rates After 5 Years, Shifting Focus from Inflation to Growth In a move aimed at reinforcing the positive sentiment generated by the recent Budget, which introduced substantial tax reductions, the Reserve Bank of India (RBI) announced a 25-basis-point cut in the repo rate, bringing it down to 6.25%. This marks the first rate reduction in five years and, coupled with tax relief, is expected to boost consumption-driven economic growth.

The immediate impact of the rate cut will be lower borrowing costs for home, auto, and small business loans, with floating interest rates automatically reducing by 25 bps.

This decision ends one of the longest high-interest-rate periods in recent history, second only to the five-year stretch following the global financial crisis of 2007-08, when rates were first revised downward on October 22, 2008. The last rate cut was in May 2020, when the RBI implemented an unconventional 50-bps reduction during the height of the COVID-19 pandemic, bringing the repo rate to 4%.

While markets and industry observers had anticipated a larger reduction and were unimpressed by the modest 0.25% cut, a notable shift in policy stance was evident in the statement from the newly appointed RBI Governor, Sanjay Malhotra. His remarks signaled a more accommodative approach toward economic growth, marking a deviation from the central bank’s traditional focus on inflation control.

The RBI expects economic activity to strengthen, with agricultural output remaining robust and the manufacturing sector poised for recovery in the latter half of 2025. The Monetary Policy Committee (MPC) projects GDP growth at 6.7% for the next fiscal year, up from 6.4% in FY25.

On the inflation front, the MPC anticipates a steady decline, forecasting inflation to ease to 4.8% by the end of this fiscal year and further to 4.2% in FY26.

Addressing the tax cuts announced in the Budget, Malhotra noted that improved employment conditions would likely enhance household consumption, further supporting economic growth.

RBI Prioritizes Growth Over Inflation with Interest Rate Cut

RBI Cuts Rates After 5 Years, Shifting Focus from Inflation to Growth For the first time in nearly five years, the Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) has lowered the benchmark repo rate, reducing it from 6.50% to 6.25%. The unanimous decision signals a notable shift in approach, contrasting with the previous bi-monthly review, where a 4:2 vote maintained the status quo. At that time, inflation had surged to a 15-month high of 6.2% in October, while GDP growth in the second quarter had slowed to 5.4%.

With inflation easing to 5.2% in December—still above the RBI’s 4% target—and growth projections for 2024-25 declining to a four-year low of 6.4%, the central bank appears to be prioritizing economic expansion over inflation control. RBI Governor Sanjay Malhotra, in his first policy review, pointed to global economic uncertainties, including stalled disinflation, reduced expectations of U.S. interest rate cuts, and a stronger dollar putting pressure on emerging markets and their currencies, including the rupee. Given these challenges, the case for supporting growth has gained prominence.

The MPC defended its decision by forecasting a further decline in inflation, expecting it to average 4.2% in 2025-26, down from 4.8% this year. This outlook relies on assumptions of stable food inflation, a normal monsoon, and strong harvests of key vegetables such as tomatoes, onions, and potatoes—historically significant contributors to price fluctuations. While inflation remains a factor, the committee has emphasized that weak economic growth is the more urgent issue, especially given the recent slowdown and the lack of a clear recovery.

Additionally, the RBI’s post-Budget stance suggests a closer alignment with fiscal policy, reflecting a cooperative approach between monetary and fiscal measures rather than conflicting strategies. However, whether the combination of tax relief from the Budget and the rate cut will successfully boost consumption, encourage private investment, and stimulate growth remains uncertain.

Had the MPC met just a week later, it might have had even stronger justification for the rate reduction, as January’s inflation is expected to decline to around 4.5%. With a new Governor in place and an upcoming appointment for the Deputy Governor overseeing monetary policy, the RBI could consider adjusting the MPC’s review schedule to better align with the latest economic data. Such a shift could enhance the responsiveness of monetary policy, making it more data-driven and adaptable to real-time economic conditions.

RBI Cuts Repo Rate but Warns of Global Growth Challenges

RBI Cuts Rates After 5 Years, Shifting Focus from Inflation to Growth In his first policy announcement, Reserve Bank of India (RBI) Governor Sanjay Malhotra revealed that the Monetary Policy Committee (MPC) unanimously decided to lower the repo rate by 25 basis points (bps) to 6.25%—the first rate cut in nearly five years. While the move aims to stimulate economic growth amid moderating inflation, Malhotra also cautioned about external risks affecting India’s economy.

With inflation easing, the RBI seized the opportunity to adjust monetary policy, despite maintaining a neutral stance. The central bank also postponed two key regulatory measures by a year—one requiring banks to hold more liquid assets for contingencies and another concerning project finance. However, no additional liquidity-enhancing measures were introduced, disappointing some market participants.

Governor Malhotra explained that the MPC, considering current economic conditions, determined that a less restrictive monetary policy was appropriate. The committee will continue assessing the macroeconomic outlook before making future rate decisions. Following the announcement, the rupee appreciated by 15 paise to 87.43 against the US dollar, while the 10-year government bond yield rose by 5 bps. The Sensex, however, fell by nearly 200 points.

Economic Outlook and Inflation Trajectory

RBI Cuts Rates After 5 Years, Shifting Focus from Inflation to Growth The MPC revised its GDP growth forecast for FY25 downward from 6.6% to 6.4%, citing risks such as geopolitical tensions, protectionist trade policies, commodity price volatility, and financial market uncertainties. Growth is expected to improve slightly to 6.7% in FY26.

While inflation has been a persistent concern, particularly due to food price fluctuations, recent trends indicate moderation. Retail inflation dropped to a four-month low of 5.22% in December, largely due to easing food prices. The MPC maintained its inflation projection at 4.8% for FY25, expecting it to decline to 4.2% in FY26.

The committee anticipates a reduction in food inflation, supported by strong monsoon-driven agricultural output. However, it remains cautious about risks stemming from global financial market volatility, fluctuating energy prices, and adverse weather patterns, all of which could impact inflation.

Future Rate Cuts and Market Reactions

RBI Cuts Rates After 5 Years, Shifting Focus from Inflation to Growth The rate cut, coupled with the government’s fiscally prudent Budget for 2025-26, is expected to provide economic stimulus. Economists anticipate another rate reduction in April, but opinions differ on the extent of future cuts. Kotak Mahindra Bank’s Chief Economist Upasna Bhardwaj predicts a shallow rate cut cycle of 25-50 bps, while Nomura forecasts a more aggressive 75 bps reduction over the year.

Despite the RBI’s efforts to inject liquidity into the banking system, some banks have remained hesitant to lend in the call money market, opting instead to deposit funds with the central bank. Malhotra urged lenders to participate more actively in interbank lending to facilitate better monetary policy transmission.

Market responses to the policy decision were mixed. While the RBI’s assurances on liquidity offered some comfort, market participants expect further measures to enhance durable liquidity in the coming months. Experts suggest that seasonal trends, such as a lean credit period and an anticipated RBI dividend, could help improve liquidity conditions, potentially paving the way for additional policy adjustments.