RBI cuts repo rates by 25 bps; first cut in nearly 5 years

7 Feb 2025 , 12:22 PM

WHAT CHANGED SINCE THE DECEMBER 2024 MONETARY POLICY

In the last two policy statements, there have been some early moves by the RBI. In the October 2024 monetary policy, the RBI moved its monetary stance from sustained accommodation to a neutral policy stance. Then, in December 2024, the  RBI cut the CRR by 50 bps to 4.0% to bridge the widening liquidity gap in the financial markets. However, despite the Fed cutting rates by 100 bps since September 2024, the RBI had refrained from cutting rates. Let us turn to data flows since the December policy.

Consumer inflation continues to be elevated at above 5.2%, although the intensity is tapering. IIP growth was driven by manufacturing to above 5% while core sector growth has hovered around the 4% mark in last few months. The current account deficit came in lower than expected at 1.2% of GDP for Q2-FY25, but things could get worse in Q3 and Q4. However, the real concerns are global. Trump is triggering an all-out trade war and China is all set to devalue the Yuan to revive growth. The impact has been felt on the rupee, which has weakened to ₹87.5/$. In this background, the Feb-25 monetary policy was announced.

REPO RATES CUT BY 25 BPS, NO CHANGE IN CRR

The cut in repo rates by 25 bps was largely expected by the markets, although its merits and demerits will be debated in the coming days. For now, the RBI has taken the rate cut decision based on expectations of a further fall in inflation and the first advance estimate (FAE) of GDP growth for FY25 at just 6.4%. However, there are also some questions over the rate cuts. For instance, inflation at 5.22% is still well above the 4% RBI target. More importantly, rate cuts will weaken the rupee further, which has already cracked to ₹87.50/$. Also, the policy has not offered any guidance on the future trajectory of rate cuts.

On the liquidity front, one would have logically expected another CRR cut, considering that the system liquidity deficit continues to be close to ₹1.96 Trillion, and a 50 bps CRR cut could have easily contributed ₹1.20 Trillion. However, the RBI is apparent wary of blunting too many monetary tools at the same time. It remains to be seen how liquidity is managed.

HIGHLIGHTS OF RBI POLICY STATEMENT – FEBRUARY 2025

After 11 successive meetings of status quo on rates, the RBI cut rates by 25 bps, the first rate cut in nearly 5 years. The stance of the policy was retained as “Neutral.” Here are the key takeaways from the MPC statement.

• RBI cut repo rates by 25 bps to 6.25% and retained the stance of the policy at “Neutral”. The rate cut decision and the stance decision were voted for unanimously. This reduces the SDF (reverse repo) rate to 6.00% (25 bps below repo), while the bank rate and the marginal standing facility (MSF) rate are reduced to 6.50% (25 bps above the repo rate).
• After cutting the cash reserve ratio (CRR) by 50 bps from 4.5% of NDTL, to 4.0% of NDTL in the December 2024 policy, the RBI maintained status quo on CRR in the February 2025 policy. With the system liquidity deficit still at ₹1.96 Trillion, another CRR cut was expected to bridge the current liquidity gap, but that was not to be.
• The GDP estimate for FY26 has projected at 6.7%. It may be recollected that in the December policy, the GDP growth estimate for FY25 had been cut by 60 bps from 7.2% to 6.6%. However, the RBI estimate for GDP growth for FY25 is still 20 bps higher than the first advance estimates (FAE) put out by MOSPI in January. We have to await the second estimate of GDP on February 28, 2025.
• The inflation forecast for FY26 has been pegged at 4.2%, which is sharply lower than FY25; betting on tapering of food inflation. In December 2024 policy, the RBI MPC had upped the FY25 inflation forecast by 30 bps from 4.5% to 4.8%. Inflation has averaged 4.93% in the first 9 months, so the RBI is expecting inflation to sober sharply in Q4.

In a sense, the rate cut and the benign inflation projection are largely in line with the efforts of the government in the Union Budget 2025-26.

RBI MPC PEGS FY26 INFLATION AT 4.2%

For FY26, the RBI has pegged its inflation estimate at 4.2%; largely along expected lines. This is sharply lower than the 4.8% inflation estimate for FY25. Going ahead, the RBI sees significant softening of interest rates in FY26 on the back of tapering food prices due to a robust Kharif and hopes of a good Rabi this year. Also, India’s recent policies have largely decoupled the economy from the global oil price risks, although imported inflation is still a concern due to weak rupee. The RBI inflation projection of 4.2% for FY26 is distributed as follows. For next 4 quarters; RBI projected inflation for Q1FY26 at 4.5%, Q2FY26 at 4.0%, Q3FY26 at 3.8%, and Q4FY26 at 4.0%. CPI inflation is likely to trend progressively lower.

RBI MPC PEGS FY26 REAL GDP GROWTH AT 6.7%

In the previous December 2024 policy, RBI cut GDP estimates for FY25 by 60 bps from 7.2% to 6.6%. However, this is still 20 bps higher than the first advance estimate (FAE) of GDP growth pegged at 6.4% by MOSPI. The RBI expects a revival in agriculture and industry to sustain growth in the coming fiscal year. Also, the massive tax reliefs offered in Union Budget 2025-26 is expected to give a consumption boost to the economy. On the capex front, while capex may not have grown in absolute terms, it is still likely to be 26% higher in the next 15 months, compared to the average of the last 9 months. The FY26 GDP growth projection of 6.7% has been broken up quarter-wise as follows. ForQ1FY26 at 6.7%, Q2FY26 at 7.0%, Q3FY26 at 6.5%, and Q4FY26 also at 6.5%. However, overall impact may be muted as global concerns could be an overhang for exports growth.

KEY POLICY SHIFTS ANNOUNCED BY RBI, OUTSIDE MPC AMBIT

RBI monetary policy went beyond monetary numbers to signal a shift at a policy level. Here are some key announcements.

• The RBI plans forward contracts on government securities. Unlike interest rate futures, which managed short term risk, the forward contracts on government securities will push insurer and pension funds to manger longer term interest rate risk.
• RBI will conduct a comprehensive review of trading and settlement timings across various markets. The idea is to make available such derivative products on 24X5 basis, with payment systems round the clock. A working group has been set up for the same.
• The feature of additional factor authentication (AFA) will be extended to foreign digital transactions also. This is likely to offer greater security for global digital transactions too.

In the last 3 MPC meetings, there has been a shift in stance, cut in CRR, and now, a cut in the repo rate too. We await sharper insights into the policy when the minutes are published on February 21, 2024; ahead of the next MPC meeting on April 07-09, 2025.