By Aastha Gudwani
As widely expected, the RBI MPC reduced the policy repo rate by 25 basis points (bp), to 6.25 percent. The decision was unanimous, with all six MPC members voting for a cut. The decline in inflation, further softening of food prices, transmission of past monetary policy actions and slower growth so far this year (versus FY23-24) opened up policy space for the MPC to ease. While the cut was much anticipated, the governor was quick to clarify that the decision for a “less restrictive monetary policy” should not be read as an indication of forward guidance. Accordingly, the monetary policy ‘stance’ was retained as ‘neutral’.
It is clear that current uncertainty and high volatility in global financial markets warrants caution by the MPC. We believe this was the guiding principle behind retaining a neutral stance. That said, markets reacted negatively with G-sec yields rose despite a repo rate cut. Add to this, the RBI did not announce any liquidity infusion measures alongside the policy announcement. That said, Governor Malhotra reiterated the RBI’s commitment that it will be “very very proactive and will take appropriate measures to ensure orderly liquidity conditions and that the RBI is committed to provide transitory and durable liquidity”. The RBI has already purchased Rs 300 billion-plus of OMO on screen (as of 26 January) and announced a further Rs 600 billion of OMO purchases. We expect additional measures as liquidity conditions warrant. For now, liquidity deficit conditions have eased amid improved government spending.
A quick comparison of the monetary policy statements between February 2025 and December 2024 offers some insights on the rationale behind today's rate cut. The December statement argued for keeping rates on hold to bring inflation down to support growth, while the February statement is in favour of a rate cut to support growth. This suggests that latest data showing lower inflation and modest improvement in growth is behind the decision to cut. As for FY26, the MPC expects real GDP growth to improve to 6.7 percent (from 6.4 percent in FY25) and CPI inflation to soften further to 4.2 percent (from 4.8 percent), with risks evenly balanced.
This was Governor Malhotra's maiden monetary policy meeting. A couple of things stood out to us in terms of future policy direction from this policy. First, the RBI said it will look to use the flexibility embedded in the flexible inflation- targeting (FIT) framework. It also intends to further refine the building blocks of this framework by improving forecasting of key macroeconomic variables. This suggests that the RBI could start to gradually move away from its fixed 4 percent CPI inflation target and instead embrace a range, especially when faced with CPI shocks, such as those from volatile vegetable prices.
Second, the RBI's consultative approach while designing regulations will continue and enough time will be given to ensure smooth implementation and transitioning. Accordingly, in the post-policy conference call, the governor highlighted that change in Liquidity Coverage Ratio (LCR) requirement will be implemented not before 31 March 2026.
Apart from a very comprehensive and candid opening statement by the governor, the post-policy conference call was also insightful. Notably, an internal review of the economic capital framework is underway, which may result in the contingency buffer requirement being revised, thereby affecting the RBI's dividend calculation. In addition, the governor also estimated that given the current growth-inflation dynamics, real rates stand at 1.5 percent.
The February policy statement was a “thoda hai, thode se zyaada ki zaroorat hai”. We still expect another 25bp cut in April, despite the neutral stance of the policy statement. The unanimous vote for a cut, in addition to the confluence of near-term low growth and the RBI’s inflation forecasts being closer to target support our view for continued easing in April.
(Aastha Gudwani is India Chief Economist, Barclays.)
Views are personal and do not represent the stand of this publication.
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