RBI’s cautious policy stance
Central bank’s first interest rate cut in five years is minimal and unsurprising considering the many external volatilities
The RBI Monetary Policy Committee (MPC) has finally reduced interest rates — by 25 basis points to 6.25%; one basis point is one-hundredth of a percentage point — after five years or May 2020, to be precise. This comes against the backdrop of a sharp slowdown in GDP growth in the current fiscal year (2024-25). RBI’s and finance ministry’s assessment (as per the 2024-25 Economic Survey) is that GDP growth will continue to be sub-7% for the next fiscal year as well. MPC expects it to be 6.6%, which is within the Economic Survey’s range of 6.3%-6.8%. The Union Budget has already done its bit to boost growth with the upward revision in income tax slabs which, it estimates, will boost the disposable incomes by ₹1 lakh crore.
By lowering interest rates — analysts believe Friday’s announcement will be followed by at least one more reduction — RBI has given a further boost to disposable incomes of households who will now see a reduction in their mortgage payments. This is welcome news for the economy. The benefits of Friday’s repo rate cut will only help the economy if banks bring down mortgage rates via the transmission mechanism. Sometimes, banks are quick to pass on higher rates to consumers but tend to delay the percolation of reduction in policy rates. To be sure, lending rates are not the only area where the efficacy of monetary policy is contingent on commercial banks. The governor’s statement also calls on the banks to “actively trade among themselves in the uncollateralised call money market” instead of “passively parking funds with the Reserve Bank”, which takes away liquidity from the market.
While interest rates were the most watched aspect of Friday’s announcement, there were many other important aspects to this MPC meeting. One, it is the first after the new RBI governor, Sanjay Malhotra, has taken charge. It is also the MPC’s first meeting after Donald Trump assumed office as the US president, an event that has thrown global markets and geopolitics into a state of chaos. The new governor, as has been the established tradition, has given a sense of continuity with improvement vis-à-vis the functioning of RBI.
His statement was categorical that the flexible inflation targeting framework has served India’s economy well rather than stoke uncertainties with debates such as whether RBI should be targeting core instead of retail inflation. He has also made a welcome statement that the central bank is committed to making advances in “use of new data, improving nowcasting and forecasting of key macroeconomic variables and developing more robust models”. Another keenly watched aspect of the MPC meeting was RBI’s communication on the foreign exchange markets. The rupee, like most other currencies, has been losing value vis-à-vis the dollar and India’s foreign exchange reserves, as of January 31 (latest available data), have fallen to $630.6 billion, from $675.65 billion in early November. This volatility and pressure in forex markets was one of the red flags for lowering interest rates. RBI has reiterated its stated principle that its forex market interventions are aimed at maintaining “orderliness and stability, without compromising market efficiency” and the “exchange rate of the Indian Rupee is determined by market forces”.
These external volatilities have prompted RBI to cautiously stick to a neutral policy stance despite finally cutting interest rates. Caution with pragmatism should be the way forward in this turbulent environment.
