The Monetary Policy Committee (MPC) of the RBI reduced repo rate by 25 bps to 6.25% in its Feb-25 policy review, while retaining the stance at ‘neutral’. This marked the first rate cut in as many as 5 years and the first revision in rate since Feb’2023.

In particular,

• The rate cut decision was unanimous, backed by all members  
• All the six MPC members also voted to continue with the neutral stance of monetary policy and to remain unambiguously focused on a durable alignment of inflation with the target, while supporting growth.

Macroeconomic Outlook

Compared to NSO’s first advance estimate of 6.4% GDP growth for FY25, RBI introduced next fiscal year’s GDP growth at 6.7% 

On the other hand, CPI inflation forecast for FY25 was retained at 4.8% with Q4 estimate at 4.4% (revised lower by 10 bps). For FY26, CPI forecast was introduced at 4.2% 

In the Governor’s maiden remarks as well as the accompanying monetary policy statement, we noticed some nuanced changes in language.

“We will continue to improve the macroeconomic outcomes in the best interest of the economy using the flexibility embedded in the framework while responding to the evolving growth-inflation dynamics”.

• This alludes to greater flexibility, possibly with respect to the level of inflation target as well as RBI’s response function to evolving macroeconomic conditions.

 “To conclude, 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”

• This highlights the increased concerns on the growth slowdown.

 “These growth-inflation dynamics open up policy space for the MPC to support growth, while remaining focussed on aligning inflation with the target”.

• This possibly indicates a subtle shift in favour of growth, vis-à-vis inflation

“This (i.e., global uncertainty) calls for the MPC to remain watchful. Accordingly, the MPC unanimously voted to continue with a neutral stance. This will provide MPC the flexibility to respond to the evolving macroeconomic environment”.

RBI leaves the door open for subsequent action to be data/milieu dependent.

Rationale for Rate Decision

The backdrop for Feb-25 policy review had turned challenging amidst escalation in geoeconomic uncertainty and its spillover impact on domestic markets. The weakness in INR that began in Oct-24 onwards, has picked up pace in recent months. INR has emerged as one of the weakest performers in CY25 so far, reflecting the strength in USD amidst heightened geopolitical/trade uncertainties as well US exceptionalism.

• The FX intervention to curb volatility in INR by RBI resulted in a sizeable drag on core liquidity in the money market.

Against this backdrop, RBI rate reduction is likely to have been driven by incremental improvement in domestic macroeconomic condition on three counts –

• First, visibility of CPI inflation easing Q4 FY25 onwards, on account of winter seasonality and healthy Rabi crop prospects. Against the projected 4.8% in FY25, RBI’s own forecast projects CPI inflation moderating to 4.2% in FY26.
• Second, fiscal consolidation demonstrated by the 2025-2026 Union Budget, while improving the quality of spending.
• Third, RBI had already laid the preconditions for a rate cut today by announcing a slew of liquidity easing measures (OMO purchases, VRR auctions etc) earlier

Outlook

With the commencement of the shallow rate easing cycle, we believe that MPC can reduce the policy rate by another 25 bps in Apr-25, followed by a status quo. Front loaded action on liquidity should serve well, keeping in mind the global macroeconomic backdrop – which imparts downside risks to growth, and upside risks to inflation.

Liquidity and Gsec View

The rate cut offers comfort to the bond market, in addition to Governor’s commitment to “proactively take appropriate measures to ensure orderly liquidity conditions”. However, no specific or new measures have been taken on the liquidity front.

From a demand-supply perspective, net g-sec borrowing at 3.2% of GDP in FY26 – as per the recent Union Budget, will be the lowest in the post Covid years. On the supply side, the partial absorption of g-sec supply by the route of OMO purchases conducted by RBI will be highly supportive. However, the deferment of the revised LCR guidelines (which was initially estimated to generate Rs 3-4 trillion HQLA led g-sec demand from banks) would have a minor negative impact.

Amidst these pulls and pressures, we continue to remain bullish on Indian bonds. However, we now fine-tune our g-sec yield forecast for Mar-25 to 6.60% from 6.50% earlier and for Mar-26 to 6.40% from 6.25% earlier.

Key Regulatory and Developmental Announcements

• The RBI is expanding the range of interest rate derivatives, including forward contracts in Government securities, to help market participants better manage interest rate risks. These measures aim to support long-term investors like insurance funds and improve the pricing of bond-related derivatives.
• SEBI-registered non-bank brokers will soon be granted direct access to the NDS-OM platform, allowing them to execute transactions in government securities on behalf of their clients. This move is intended to widen access to the platform and enhance market liquidity.
• A working group has been set up to review the trading and settlement timings across financial markets regulated by the RBI, considering factors like electronification and 24X7 payment systems. The group is expected to submit its recommendations by April 30, 2025.
• The RBI is launching exclusive ‘bank.in’ and ‘fin.in’ domains to reduce cybersecurity risks like phishing and enhance the security of digital payments and services. Banks and non-bank financial entities will be required to adopt these domains, with registrations for banks starting in April 2025.
• The RBI plans to implement an Additional Factor of Authentication (AFA) for international online transactions using Indian-issued cards, mirroring the security measures for domestic transactions. This will provide an added layer of protection for cross-border payments, and a draft circular will be issued for stakeholder feedback.

Says Suman Chowdhury, Chief Economist and Executive Director, Acuité Ratings & Research, “RBI has finally opted for the pivot by announcing a 25 bps cut in the benchmark repo rate after two years. The cut has been driven by increasing concerns on the growth momentum in the economy particularly “subdued urban consumption although it has maintained the existing neutral stance in monetary policy amidst the volatile external environment.

RBI has estimated the GDP growth for FY26 at 6.7%, a moderate improvement over the 6.4% estimated for FY25. RBI MPC has taken a favourable outlook for the inflation trajectory with a forecast of 4.2% for FY26, a 60 bps reduction to the estimate of 4.8% for FY25. The tone of the governor’s speech seems to suggest that the approach to inflation targeting will be a little more flexible.  

RBI has also provided comfort on the liquidity scenario albeit no new steps have been announced. It has also clarified that the intervention in the forex market will be measured based on excessive and disruptive moves in the currency.

We believe that RBI MPC has initiated a shallow rate cycle with low visibility and limited clarity on the future rate cuts. The retention of the neutral stance highlights that the policy direction may be aligned suitably depending on the incoming data points and the external environment.

The impact of the rate cut is likely to be limited at this stage due to the following factors:

• The monetary policy stance remains neutral, indicating that the trajectory on the rates is uncertain amidst a volatile external environment. This may not induce the banks and other lenders to cut rates immediately (except those linked to the benchmark).
• Importantly, banks are witnessing lower deposit growth rates. It’s unlikely they will have the confidence to cut deposit rates at this juncture.
• While RBI has provided comfort on addressing the liquidity challenges in the system, it has not announced any new measures apart from those announced last week. Continuing tightness in the system liquidity may not facilitate an immediate transmission of lower rates.

Essentially, the rate cut is symbolic at this juncture to supplement the fiscal measures taken through tax cuts and provide a signal to the markets that monetary and fiscal policies will work in unison to support growth, going forward.”