RBI MPC Policy: Fiscally prudent Union Budget and benign inflation expectation may lead to a repo rate cut

Reserve Bank of India

By Abhishek Bisen, Head – Fixed Income at Kotak Mahindra AMC

The Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) will be announcing its decision on February 7. This will be first policy of new RBI Governor, Sanjay Malhotra, appointed in December 2024 and Deputy Governor, M Rajeshwar Rao, who has assumed charge of monetary policy in January 2025. The current benchmark repo rate stands at 6.50 percent while the stance remains at “neutral”.

Last week, Finance Minister presented the Union Budget for FY2025-26. As promised in last budget, the Central Government continued on the path of fiscal consolidation with the fiscal deficit target of 4.4% of GDP for FY2025-26 down from 4.8% of GDP (revised estimate Vs 4.9% of budget estimate) in FY2024-25. Further, the budget speech mentioned that going forward endeavour will be to keep fiscal deficit such that Central Government Debt as a percentage to GDP will be on declining path. The net borrowing is projected to be at Rs 11.54 lakh crore and gross borrowing at Rs 14.82 lakh crore for FY2025-26. We expect bond demand-supply balance to remain favourable to meet this borrowing requirement. The combined fiscal deficit (Centre plus State) is expected to be in the range of 7.10%-7.20% increasing the likelihood of India Sovereign rating upgrade in medium term.

As per the first advance estimate by NSO, the real GDP is expected to grow at 6.4% in FY2024-25 as compared to the growth rate of 8.2% (provisional estimate) for FY2023-24. However, high frequency indicators suggest that the slowdown in growth has bottomed out in Q2FY2024-25 (where growth rate was 5.4%) and the growth is expected to revive in H2FY2024-25. RBI is likely to lower its GDP growth from 6.60% for FY2024-25. The RBI bulletin for December 2024 has projected the GDP growth of 6.7% in FY2025-26.

The headline inflation data for December 2024 was printed at 5.22%, lower than 5.48% in the preceding month (November 2024) as well as lower than 14-month high of 6.21% in October 2024. The fall in inflation was the effect of decrease in food inflation to 8.39% in December 2024 lower than 9.04% in November 2024 with vegetable inflation dropping to 26.56% in December 2024 from 29.33% in November 2024. Moreover, the core inflation remained stable at 3.60% in December 2024. The RBI bulletin for December 2024 has projected the inflation of 3.8% for FY2025-26.

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Abhishek Bisen

Head - Fixed Income|Kotak Mahindra Asset Management Company

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The liquidity in the Indian banking system had tightened significantly with systemic liquidity dropping to a near 15-year low with cash deficit of around Rs 3.3 lakh crore on January 23, 2025. In respond to this, the RBI announced various measures to inject liquidity in the banking system: Rs 60,000 crore in OMO (Open Market Operations) Purchase, Rs 50,000 crore for a long dated VRR (Variable Rate Repo) auction and $5 billion for a buy/sell swap auction. These measures are expected to infuse around Rs 1.5 lakh crore into the banking system. RBI has also done Government bond purchases in the secondary market in 2nd and 3rd week of January 2025.

While the above liquidity measures and month-end spending has provided some breather to banking system liquidity and overnight call rates, the liquidity condition is likely to become tight again. Hence, we expect more measures from RBI on liquidity front in the near to medium term.

The repo rate was reduced last in May 2020, during the Covid-19 Pandemic. The interest rate seems to have peaked with most of the major economies in the globe following the path of benchmark rate cut.

The Union Budget FY2025-26, continued to be fiscally prudent, the slower GDP growth rate as per NSO and the Economic Survey 2025 (presented a day before the Union Budget FY2025-26), falling headline inflation since October 2024, and expectation of lower inflation in coming financial year, we expect a 25-bps rate cut in the forthcoming policy with the stance remaining unchanged at “neutral”.

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