The February 2025 Monetary Policy Committee (MPC) meeting came on the heels of the Union Budget, where the government introduced a significant demand stimulus of Rs 1 trillion (~USD 11 billion) through middle-class tax cuts. The key anticipation was whether the MPC would complement these fiscal measures with liquidity adjustments and rate cuts to revive economic momentum.

The MPC unanimously decided to cut the repo rate by 25 basis points (bps) to 6.25% from 6.5%, while maintaining a neutral policy stance. The decision reflects a balanced approach towards economic growth and currency stability, ensuring rate transmission progresses smoothly. Let’s look at this in detail today.

RBI Cuts Repo Rate by 25bp but Maintains Neutral Stance

RBI has maintained the repo rate at 6.5% since April 2023 after hiking it by 250 basis points between May 2022 and February 2023 to control inflation. However, with growth slowing to 6.4% in FY25, its lowest in 4 years, and inflation moderating to 5.22% in December, expectations of a policy shift had been growing. With economic indicators showing signs of softening and inflation easing, the February MPC meeting confirmed the repo rate being cut by 25 basis points from 6.5% to 6.25%.

However, the MPC unanimously decided to maintain a ‘neutral’ stance rather than shifting to an ‘accommodative’ approach, citing global uncertainties such as currency market volatility, trade tensions, and the Federal Reserve’s outlook.

Since mid-December, India's banking system has been facing a liquidity deficit, reaching a one-year high of over ₹3 trillion ($34.31 billion) in January. Bankers argue that a rate cut alone is not enough to spur credit growth if liquidity remains tight. Indian banks have seen loan growth moderate for six consecutive months through December. With liquidity drying up, lenders have been prioritizing deposit mobilization over issuing fresh credit.

Currently, only 40% of banks' loan rates are linked to the repo rate, down from 59.4% in September, according to RBI data. This means that while rate transmission should be immediate for some borrowers, the broader impact on lending rates could take time.

Indian GDP Growth Projections For FY26 Lowered

RBI revised its real GDP growth forecast for FY25 to 6.4% from the previous estimate of 6.6%, marking the second downward revision. However, it expects a moderate recovery in FY26, projecting a growth rate of 6.7%. While the rural economy shows signs of improvement, urban consumption remains sluggish. Government spending is also expected to stay modest, further weighing on growth prospects. External factors, including global uncertainties, continue to pose risks to India’s economic outlook.

Looking ahead, FY26 GDP growth is projected at 6.7%, with quarterly estimates as follows:

• Q1: 6.7%

• Q2: 7%

• Q3: 6.5%

• Q4: 6.5%

Growth will be supported by strong rabi crop prospects, improving industrial activity, sustained household spending (boosted by income tax relief), and a rebound in fixed investment due to high capacity utilization and government-led capital expenditure. However, risks remain due to geopolitical tensions, global commodity price fluctuations, and financial market uncertainties.

Inflation Moderation Driven by Food Prices

Despite economic slowdown concerns, the RBI kept its Consumer Price Index (CPI) inflation forecast largely unchanged, at 4.8% for FY25 and 4.2% for FY26. The arrival of fresh harvests has triggered a seasonal correction in food prices, further bolstered by a favorable Kharif production outlook and robust progress in rabi sowing. These trends indicate a likely continued easing of food prices in the coming months.

Furthermore, healthy reservoir levels provide a crucial buffer for Kharif sowing should monsoon activity fall short next year. The overall inflationary environment remains stable, with core inflation and the Wholesale Price Index (WPI) remaining at benign levels. However, as the favorable base effect begins to wane, WPI inflation is expected to rise marginally in the near term. Notably, if vegetable prices are excluded, CPI inflation stands at 3.9%, which is below the RBI’s target of 4%.

CPI inflation moderated to 5.2% in December from 5.5% in November, driven by a decline in food and beverages inflation to a four-month low. Inflation excluding vegetables has remained below the RBI’s 4% target for 12 consecutive months.

Key Risks in the Inflation Trajectory

While food price disinflation is expected to persist, certain factors warrant close monitoring. The inflation in edible oils poses a potential risk, with a contraction in rabi sowing of oilseeds and rising global edible oil prices, compounded by an increase in customs duties, likely to keep prices elevated. Additionally, weather-related disruptions, particularly the increasing frequency of heatwaves, could exert upward pressure on food prices.

However, edible oil inflation remained a concern, with double-digit inflation at 14.6% in December, up from 13.3% in November, due to high global prices and a recent import duty hike. The central bank anticipates inflation to average 4.3% in the first half (H1) and 4% in the second half (H2) of FY26, indicating a broadly stable inflation outlook.

Core inflation may also see a moderate rise. The central bank highlighted potential upside risks, including global financial market instability, energy price volatility, and adverse weather events.

Rate Cuts & Tax Relief to Boost Consumption

While economic growth in the first half of FY25 slowed due to base effects and temporary disruptions, the latter half is expected to see a recovery. The combined impact of fiscal and monetary measures, along with easing inflation, is likely to revive consumption and potentially trigger a broader private capital expenditure (capex) cycle over time.

Another rate cut in early FY26 could provide some relief by reducing borrowing costs, thereby supporting urban consumption. A lower repo rate would ease household EMIs, enhancing disposable income and boosting discretionary spending. While the overall impact may not be dramatic, it would benefit a wide base of borrowers, with 194.9 million personal loan accounts and 14.7 million home loan accounts recorded as of September 2024, according to RBI data.

Additionally, the ₹1 trillion tax relief announced in the Union Budget 2025 is expected to act as a consumption multiplier, providing a much-needed boost to demand. Combined with lower food inflation, these factors are likely to contribute to urban spending and economic momentum in the coming year.

Foreign capital inflows could also improve as domestic growth stabilizes, aiding currency strength. However, risks remain, particularly concerning slow disinflation in food prices due to abnormal minimum temperatures affecting Rabi yields. Additionally, global uncertainties, such as potential tariff hikes from a new Trump administration, could drive up commodity prices and impact core inflation.

Global Economic Stability & Indian Economy

Despite external market volatility, India’s external position remains relatively stable. However, risks persist due to financial market fluctuations, uncertain trade policies, and ongoing geopolitical tensions. The Indian rupee has been under pressure due to sustained Foreign Portfolio Investment (FPI) outflows and a strengthening US dollar amid narrowing interest rate differentials with the US. Since October, net FPI outflows have amounted to USD 21 billion, highlighting investor caution amid global uncertainties. Recent data suggests that the RBI has taken a calibrated approach to managing the rupee, allowing gradual depreciation while maintaining overall stability. The RBI Governor has reaffirmed the commitment to ensuring orderly exchange rate movements without targeting specific levels.

While global economic growth is below historical averages, trade activity remains resilient. Risks such as geopolitical tensions, policy uncertainties, and a slower pace of disinflation continue to challenge global stability. Additionally, the strong US dollar is pressuring emerging market currencies, increasing financial market volatility.

India’s current account deficit (CAD) is projected at 0.9% of GDP for FY25, reflecting a comfortable position. Forex reserves, despite a recent decline, remain robust. Geopolitical risks remain a critical concern, particularly due to the ongoing conflicts in Ukraine and the Middle East. Additionally, the risk of trade wars has escalated following the US’s imposition of sanctions on key neighboring countries and China. Heightened trade tensions could have an adverse impact on global trade flows and, consequently, India’s CAD in FY26. As a result, India’s policymakers will need to closely track global developments and implement proactive measures to mitigate any adverse economic spillovers.

Strong Relationship Between FPI Flows & RBI’s FX Interventions

RBI’s interventions in the FX market have been crucial in mitigating capital flow volatility, which is the primary driver of exchange rate fluctuations in India. A study published by RBI found, foreign exchange interventions—both spot and forward—effectively counter capital flow volatility with symmetric effects of purchases and sales. This approach underscores the RBI’s "leaning against the wind" strategy to smooth excessive volatility, irrespective of its source.

There is significant co-movement between FPI flows and RBI’s FX interventions. Key episodes of heightened volatility included the global financial crisis (2008-09), taper tantrums (2013), the IL&FS crisis (2018), the COVID-19 pandemic, the Russia-Ukraine conflict, and synchronized monetary tightening during 2022-23. Despite sustained FPI outflows and a strong US dollar in the second half of 2024, the RBI’s judicious interventions ensured reduced volatility in the Indian Rupee compared to other major currencies. However, forex reserves, which peaked at $704.885 billion in September 2024, have since declined due to interventions and revaluation effects. These measures highlight the RBI’s commitment to maintaining exchange rate stability.

RBI Injects Liquidity Into Indian Markets

System liquidity, which was in surplus from July to November 2024, turned into a deficit in December 2024 and January 2025 due to factors such as advance tax payments, capital outflows, FX operations, and an increase in currency in circulation. To combat this, the RBI announced liquidity infusion measures worth ~₹1.5 trillion to ease the banking system's liquidity crunch. The RBI has taken multiple steps, including Variable Rate Reverse Repos (VRRs), Open Market Operations (OMOs), and FX swaps, to ensure adequate liquidity. The Governor also announced delays in Liquidity Coverage Ratio (LCR) norms, providing relief for banks.

RBI’s commentary in the February MPC aligns with expectations, with liquidity support viewed as a sustainable positive for the economy. The following financial market measures were introduced:

• Introduction of forward contracts in Government securities to help long-term investors, such as insurance funds, manage interest rate risks and enable efficient pricing of bond-related derivatives.

• Non-bank brokers registered with SEBI can now access the RBI electronic trading platform for secondary market transactions in government securities.

• A comprehensive review of trading and settlement timing for financial markets regulated by the RBI is planned.

More Rate Cuts Expected, but at a Measured Pace

Economists believe that easing liquidity conditions could serve as a prelude to a longer term monetary easing policy, especially as government spending picks up toward the financial year-end. And with economic growth remaining sluggish, further rate cuts of 50–75 basis points are expected over the coming year. RBI is likely to adopt a cautious approach in easing monetary policy to navigate uncertainties in both domestic and global markets. Any acceleration in growth could depend on a more aggressive monetary easing by the Federal Reserve or improvements in export performance. For now, the RBI’s stance suggests a steady approach to managing liquidity and supporting growth while keeping inflation risks in check.

We view the governor’s first policy as a continuation of the previous regulatory approach. Future rate cuts are expected to be data-dependent, influenced by inflation trends, global economic conditions, asset prices, and domestic growth. Should economic growth weaken further, another rate cut could be considered in the April 2025 policy review. The coming months will determine the MPC’s trajectory based on evolving macroeconomic indicators. For now, the coordinated fiscal and monetary policy measures are expected to support consumption-led growth while keeping inflation in check.