After maintaining the repo rate unchanged for two years, the six-member monetary policy committee (MPC) on Friday unanimously cut it by 25 basis points to support growth, which dipped to a seven-quarter low in the second quarter, amid easing retail inflation.

The repo rate (the interest rate at which banks draw funds from RBI to overcome short-term liquidity mismatches) cut, which was widely expected by bankers and economists, from 6.50 per cent to 6.25 per cent complements the Union Budget’s bid to boost consumption through tax relief.

This comes even as the rupee has been reeling under depreciation pressure since November 6, 2024, the day the US presidential election results were announced.

The MPC meeting, which was new Governor Sanjay Malhotra’s first since assuming office on December 11, 2024, also decided unanimously to maintain a neutral stance. The reason for this is that excessive volatility in global financial markets and continued uncertainties about global trade policies coupled with adverse weather events, which pose risks to the growth and inflation outlook.

The last time the repo rate stood at 6.25 per cent was between December 7, 2022, and February 08, 2023. Retail inflation eased for the second successive month in December 2024, to a four-month low of 5.22 per cent from 5.5 per cent in November 2024. GDP growth in the second quarter of FY25 fell to a seven-quarter low of 5.4 per cent from 6.7 per cent in the preceding quarter.

Though no specific measures such as open market operation (OMO) purchase of government securities and USD/INR buy/sell swaps were announced to boost the banking system’s liquidity, which turned into a deficit from December 2024, the Governor assured that RBI is committed to providing sufficient system liquidity.

Less restrictive policy

Malhotra said, “The MPC noted that inflation has declined. Backed by a favourable outlook on food and continuing transmission of past monetary policy actions, it is expected to further moderate in 2025-26, gradually aligning with the (4%) target.

“The MPC also noted that though growth is expected to recover from the low (of 5.4 per cent) of Q2 (July-September) of 2024-25, it is much below that of last year. These growth-inflation dynamics open up policy space for the MPC to support growth while remaining focussed on aligning inflation with the target.”

Malhotra observed that, considering the existing growth-inflation dynamics, the MPC, while continuing with the neutral stance, felt that a less restrictive monetary policy is more appropriate at the current juncture. The MPC will take a decision in each of its future meetings based on a fresh assessment of the macroeconomic outlook.

He emphasised that the less restrictive monetary policy is only for this particular MPC meeting, and not going forward.

Rate cut transmission to take time

Ajit Velonie, Senior Director, Crisil Ratings, opined that the transmission of the rate cut to bank lending rates for new loans would take time. This is because the cost of funds for banks is sticky given the competition for deposits. Therefore, banks may price this in through a wider spread over the benchmark rate.

As for banking system profitability, he foresees net interest margins (NIMs) and return on assets (RoA) declining next fiscal. This is because, a rising proportion of floating rate loans is benchmarked to external rates — over 40% of the total loan book — which are expected to move in tandem with the repo rate. Consequently, the assets side will see a quicker downward repricing overall, compared with the liabilities side.

Published on February 7, 2025