The fall in India’s consumer price inflation print to 2.82 per cent in May appears to vindicate the Monetary Policy Committee’s (MPC’s) latest stimulative, growth-plus policy. But Governor Sanjay Malhotra also indicated that after these front-loaded cuts (in repo rate and cash reserve ratio), monetary policy would have little room to undertake further easing — unless the incoming data change.

Even so, Reserve Bank of India (RBI) can ensure that monetary easing aids the economy, by focusing on policy rate transmission. Studies show that monetary policy actions in India take two to three quarters to impact output, with a partial pass-through of rate cuts. Economists recognise three main channels through which monetary transmission works. The first is the interest rate and credit channel, where cheaper cost of funds and more liquidity impels lenders to step up credit and lower lending rates, stoking consumption. Transmission through this channel works best when bank balance sheets are in good shape — as they are now. The second channel is through asset prices, where lower interest rates spur households to invest in homes and companies to buy fixed assets. Three, lower rates trigger currency depreciation, making imports cheaper and exports more competitive, aiding GDP growth. In India, of these three channels, two are unlikely to be effective in the near term. With households hamstrung by slow income growth and companies by low demand visibility, lower interest rates alone are unlikely to spur investments. A depreciating rupee may not stimulate exports, amid tariff threats and geopolitical uncertainty.

The best bet for quick monetary transmission at this juncture is the interest rate channel to boost consumption. RBI data on lending and deposit rates of banks until end-May suggests that the transmission of rate cuts by banks in this easing cycle has been no better than in previous cycles. Between February 1 and May 31, 2025, as the MPC cut rates by 50 basis points and RBI opened the taps of liquidity, banks’ weighted average lending rate on new loans fell by just six basis points and legacy loans by 17 basis points. Weighted average interest rates on new deposits fell by 26 basis points, but legacy deposits saw almost no change in their costs. It remains to be seen if graded CRR cuts kicking in from September manage to accelerate deposit rate cuts, which hold the key to lending rates. On the lending side, the advent of External Benchmark-based Lending Rate (EBLR) loans which use the repo rate as their peg have speeded up the pace of transmission in some pockets of the credit market.

Here, private sector banks have widely adopted EBLR loans, with 86 per cent of their loan book now repo-linked, but public sector banks still have over half of their loan books pegged to the MCLR (Marginal Cost of Funds-based Lending Rate). This results in tardy transmission. EBLR is also used mainly in home loans. Nudging banks and NBFCs to adopt EBLR lending may improve monetary transmission.

Published on June 15, 2025