With the Reserve Bank of India’s Monetary Policy Committee (MPC) concluding its first policy meet of 2025 and last of the current financial year on Friday (January 7), the popular opinion emerging is of an end to the longest pause by the MPC with a rate cut announcement. This will be the first cut in nearly five years with the last rate cut in May 2020 when the central bank had lowered the repo rate to 4 per cent. It had later raised the interest rates seven times to reach 6.50 per cent. The pause has remained since February 2023.
Per economists, the central bank is expected to cut interest rates by 25 bps in the newly appointed RBI Governor Sanjay Malhotra’s first monetary policy review. While the new governor hasn’t made any public speeches since his appointment in December making it difficult for analysts to gauge his views on inflation and the currency, a Bloomberg report had earlier maintained that Sanjay Malhotra favours a more hands-off approach on the rupee as compared to his predecessor. Bloomberg had earlier reported that the RBI governor is showing a willingness to allow the rupee to move more freely in tandem with peers in the region.
While most economists expect a 25 bps cut, some believe it would be premature. Dhiraj Relli, MD & CEO of HDFC Securities, said, “At the upcoming MPC meeting, led by Governor Malhotra, the RBI is widely expected to cut the repo rate by 25 basis points. However, this decision remains finely balanced. The central bank may instead prioritize liquidity measures and defer the rate cut to the April policy review, particularly in light of mounting global uncertainties.”
What are the arguments in favour of the rate cut? Dhiraj Relli said, “There are several compelling arguments in favor of a rate cut. Sluggish economic growth, the government’s advance estimates, and recent efforts to boost banking system liquidity create a strong case. Just last week, the RBI announced plans to inject Rs 1.5 lakh crore into the banking system, following a December infusion of Rs 1.16 lakh crore through a 50 basis point reduction in the cash reserve ratio.” Nonetheless, he added, challenges persist. “Inflation remains above the RBI’s medium-term target of 4 per cent, and increasing global trade-related uncertainties have added complexity to the economic outlook. The government’s fiscal prudence, reflected in the recently announced Union Budget, points toward a downward trajectory for interest rates. While the broader direction seems clear, the precise timing of the next rate cut remains uncertain,” he said.
What has changed since last MPC meet? Is a rate cut imminent?
A lot has changed since the last monetary policy meeting of RBI held in December 2024, with the most notable being the rising volatility visible in major asset classes, especially for INR. Dipanwita Mazumdar, Economist, Bank of Baroda, said, “RBI in its upcoming policy is expected to encounter a trilemma encompassing: 1) tighter liquidity conditions, 2) depreciating INR, and 3) heightened geopolitical uncertainty. The risks were not so profound in the last policy which expressed concerns about missing growth forecast and transient risks of inflation resulting in the misalignment of the 4 per cent target.
1) Tighter liquidity: The liquidity situation started getting tighter in Jan-25 when durable liquidity went into deficit. In Jan-25 itself, forex currency assets have fallen by $14 billion. “Durable liquidity went into a deficit of Rs 40,000 crore as on 10 Jan 2025, which was not visibly present in the series since RBI started publishing the data of durable liquidity. Hence, the host of measures ranging from long term VRR and OMOs are targeted towards retaining the durable liquidity in surplus mode. On Banking liquidity front as well, incremental deposits and borrowings net of incremental investment and credit has fallen as deposits growth has shown loss of momentum albeit correction in credit growth. Hence overall tighter liquidity conditions build up case for an easier monetary policy response on part of RBI,” said Dipanwita Mazumdar.
2) Depreciating INR: Strengthening DXY, firmer US 10Y yield amidst expectation of heightened trade spats have impinged on INR. Post November onwards, Dipanwita Mazumdar said, when US election results were announced, the yield differential between India and US has started falling, even pressure on INR exacerbated during the same period. From Nov-24 onwards, FPI outflows amounted to $7.5 billion (till date). “Ideally, in times of volatility, RBI should stand pat on rates. However, since the downward arrest in INR is more acute, thus, to arrest drain on domestic liquidity, a softer interest rate regime would provide more comfort,” she added.
3) Heightened geopolitical uncertainty: With Donald Trump coming back to power, there have been growing risks of a tariff war. As of now, on 1st February, US imposed a 25 per cent additional tariff on imports from Canada and Mexico and a 10 per cent additional tariff on imports from China. However, for Canada and Mexico, there has been a reprieve in tariff, while China was prompt enough to retaliate the same on some US goods. While India is insulated as of now, with share in US export basket at 18 per cent and merchandise trade balance with the US at $36 billion (FY24 data), there do arise downside risks to growth from heightened uncertainty as pointed out by IMF in its latest report. “Thus, to support growth, RBI is expected to embark on the rate cut cycle. For other economies since the rate cut has started much earlier, they have the degree of freedom to go in for a “wait and watch” approach,” Dipanwita Mazumdar said.
Further, with inflation expected to soften and even World Bank data stating that global commodity prices especially food prices such as cereals, edible oils are tempering down, the RBI gets the headroom to lower rates. “Our in-house BoB ECI which tracks high frequency price data is also showing considerable moderation tracking at 4 per cent. Thus, against this backdrop, we expect it is the opportune time for beginning of the rate cut cycle of India, albeit at a softer pace on a cumulative basis,” the BoB analyst report stated.
The brokerage firm also said that the growth prospects also require the desired handholding of monetary policy when inflation risks are still contained, and fiscal consolidation of the government is underway.
And to conclude…
Balancing and counterbalancing all macro and geopolitical factors, Bank of Baroda maintaied that there remains space for 25 bps rate cut by RBI in the upcoming policy. The cumulative cut in the entire cycle could be ~50-75 bps, it added while maintaining “beginning of a shallower rate cycle by RBI seems appropriate”.