The Reserve Bank of India (RBI) cut its repo rate by 50 basis points from 6 per cent to 5.5 per cent on June 6. With this, there has been a cut by 100 basis points in the repo rate since February, 2025. Also, the RBI has been reportedly pumping in liquidity aggressively in one way or another in the last few months.
Also, the RBI has announced a cut in the cash reserve ratio (CRR) from 4 per cent to 3 per cent. This will reportedly release additional funds of about ₹2 lakh crore from September to December 2025, which is when the policy change will come into effect. The timing of this otherwise desirable change makes the monetary policy in the near future also very expansionary.
Inflation worries
What is wrong with all this?
It is true that the inflation rate touched a six-year low of 3.2 per cent in April 2025. This is an important reason why the RBI has been using an expansionary monetary policy for a while. However, there are some other facts as well. The inflation rate came down close to the 4 per cent target a few times in the last five years but then shot up again. The average inflation rate has been somewhat stuck for about five years at more than 5 per cent.
So, it is premature to say that the inflation rate has come down in a sustainable way. In any case, the inflation rate at 3.2 per cent has not fallen to a very low level relative to the target of 4 per cent.
All this implies that while some loosening of the policy was indeed a good idea, the aggressive loosening was not warranted. This is the situation in the absence of any cost-push factors like a jump in oil prices, or some disruption in supply chains. If we allow for some such serious possibility in the next few quarters, then the inflation rate can get even higher — more than what can happen due to just the very loose monetary policy.
Does higher inflation matter? Yes. Even if the allocation of resources is not affected, the less well-informed and the less well-off people tend to lose. On the other side, the government gains through, what economists call, the inflation tax. 0It is a different matter that this has been masquerading for a very long time as a part of the dividend income from the RBI to the government! The story does not end there. The inflation tax is, like other taxes, distortionary. So, there is also a loss in welfare for the economy as a whole.
Growth imperative
We come now to another important reason why the RBI has loosened monetary policy. This is about the gross domestic product (GDP).
However, there is no “growth recession” at all in India. It is true that the estimated growth rate of GDP at 6.5 per cent is below the potential and the aspired growth rate but this matter is in the domain of development/growth economics and not in the field of monetary economics.
Monetary policy can be useful for macroeconomic stabilisation over an economic cycle but not for dealing with long-term structural or persistent issues or those related to the “new normal” in GDP growth for a significantly long time now. So, again a very expansionary monetary policy is questionable.
What is needed here is very different and it is in the purview of the Centre and the State governments, and not the RBI. And, it goes well beyond even fiscal policy.
Credit-deposit growth
We come now to another aspect which is even less well appreciated. Some argue that credit growth in India has not been high and accordingly it helps to have an expansionary monetary policy so as to improve credit growth. But we need to be careful. Credit growth is not high because it is related to deposit growth, which is not high in India. This is, in turn, due to the changing preferences of the investors from banks, etc. to financial markets, directly or indirectly, at a fast pace or a relatively slow pace, for the last few years.
It is true that the existing bank deposits, by and large, nevertheless, simply change hands so that the level of deposits does not fall as a consequence of a shift in asset preferences. However, it does make the path of bank deposits relatively flatter. Accordingly, the growth of credit gets affected.
In this context, the RBI cannot engineer or force a higher rate of growth of real credit in the economy through an expansionary monetary policy. The main effect of the policy under the circumstances can be on nominal credit. This can indeed “improve” but this is an accompaniment to the plain and simple higher inflation, which can follow a very expansionary monetary policy.
In any case, relatively slow growth of real credit does not imply that the growth rate of real funding is low in the economy. The reason is simple. Bank credit is one kind of funding but there are other kinds of funding. Since investors have been shifting from banks to financial markets, the funding is also, at the end of the day, shifting from bank credit to funding for, say, the initial public offerings (IPOs).
So, there is, broadly speaking, a change in the kind of funding for a given path of funding in the economy. This is not to say that the kind of funding does not matter. It does but that is a separate story. It does not really help here if the RBI uses a very loose monetary policy.
In conclusion, it is, indeed, hard to predict when so much can change over time but it is also important to spell out where logic and facts are, at present, pointing. With a very loose monetary policy, we can have higher inflation once again though there can be a significant lag.
The writer is an independent economist. He has taught at Ashoka University, ISI (Delhi) and JNU