Reserve Bank of India's Monetary Policy
The Reserve Bank of India (RBI) has initiated an easy-money policy regime. On Wednesday, during the first meeting for the fiscal year 2025-26 (FY26), the Monetary Policy Committee (MPC) reduced the policy repo rate by 25 basis points (bps) to 6%. This marks the second consecutive rate cut since February.
Accommodative Monetary Policy Stance
- The monetary policy stance was changed from ‘neutral’ to ‘accommodative’.
- Governor Sanjay Malhotra explained that an accommodative stance is intended to stimulate the economy through lower interest rates, predicting further rate cuts.
- Analysts have revised the terminal interest rate expectations from 5.5%-5.75% to 5.25%-5.5%, suggesting cumulative rate cuts of 50-75 bps in the fiscal year.
Historical Context and Economic Rationale
- The RBI last shifted its stance from ‘neutral’ to ‘accommodative’ in June 2019.
- The decision to cut rates is influenced by changing growth-inflation dynamics, with tame inflation and subdued growth signals.
- The RBI reduced its real GDP growth estimate for FY26 by 20 bps to 6.5% and expects a balanced risk outlook.
Inflation and Economic Projections
- The consumer price index (CPI)-based inflation estimate for FY26 has been reduced to 4%.
- CPI-based inflation is projected to be below the RBI’s target of 4% for the first three quarters, suggesting a real interest rate of over 2%.
Market and Economic Implications
- RBI’s message to markets, banks, and corporations is clear: interest rates are expected to decrease, ensuring ample liquidity to boost growth.
- The yield on the 10-year government bond saw fluctuations but settled lower after the stance change announcement.
- The rupee's value may not be a priority as focus shifts to supporting growth, even if it results in currency depreciation.
Challenges and Concerns
- Stock markets dropped following the announcement, reflecting concerns over economic slowdown.
- Banks might face challenges due to reduced loan rates, impacting net interest margins as they align with external benchmarks.