Lost in transmission

Another interesting aspect is that the RBI has been reducing rates at a time when core inflation was inching up.

The size of the rate reduction may have been the big surprise from the June monetary policy, but there are some other interesting aspects as well. The shift in stance from accommodative back to neutral in less than two months, for instance. RBI Governor Sanjay Malhotra’s remark that the tussle between price stability and growth was only in the short run may seem to back this.

In April when the RBI switched its stance to accommodative, it was signalling, in its own words, that only two options existed for rates going forward, status quo or downward. In June, after having delivered a 50 bp rate cut, it seemed to be shuttering down stating monetary policy is left with ‘very limited space to support growth’. Read together with its remarks that price stability was a necessary but not sufficient condition for growth, the large rate cut could then be seen as either making up for lost time or perhaps to downplay expectations for the future.

Core, gold and inflation

The change in stance and RBI’s cautious optimism could probably rein in expectations of markets enthused by falling inflation and prospects of more reductions. Another interesting aspect is that the RBI has been reducing rates at a time when core inflation was inching up (from 3.6% in December 2024 to 4.2% in April 2025) though headline inflation was declining continuously. The irony of the situation will not be lost on those who remember that only last year there was pressure on the RBI to focus on core rather than headline inflation in an obvious attempt to get it to reduce rates.

The RBI is now faced with the opposite problem but it seems unfazed, attributing core inflation to rising gold prices mainly. There is further irony here considering that gold itself is believed to be a hedge against inflation. Current price movements of the yellow metal though indicate a flight to safety in uncertain times more than anything else.

On inflation, the RBI appears to be sanguine even reducing its estimate for 2025-26 to 3.7% from an earlier 4%. Its belief is predicated upon food prices behaving well during the year, which seem valid given the bumper harvests of wheat and rice and the prospects of a normal monsoon with an early onset. There is also the unintended benefit from global turmoil in the form of low commodity prices, mainly oil. The RBI believes that the anticipated global growth slowdown will continue to keep commodity prices low during the year which looks a safe bet given its current neutral stance.

Gauging the right level of liquidity in a fluid situation is tough

The liquidity measure in the shape of a 100 basis point cut in CRR was a bit of a surprise especially when systemic liquidity was already in surplus with the Rs 9.5 lakh crore infusion by the RBI since January 2025. The CRR reduction is expected to pump in another Rs 2.5 lakh crore by December 2025.  If policy rates will not do the trick, then markets may, seems to be the logic behind this largesse

While the RBI believes that that rate decisions could impact liquidity, the stance itself was intended only for policy rate guidance, not liquidity management.  The questions here are not only about its effect on credit but also on inflation management.

First, will all this liquidity and the rate cuts translate into a credit boom? The RBI admits that transmission in credit markets has been weak with lending rates dropping by only about 6 bps responding to the earlier 50 bp repo rate cut, though short-term money markets reacted positively. In fact, RBI data show that in the tightening phase (May 2022-Jan 2025) both deposit and lending rates had gone up nearly as much as the rate hikes (250 bp) but in the current slackening phase (50 bps rate cut between Feb- March 2025) deposit rates actually went up while lending rates barely moved.

Second, there is the liquidity-inflation nexus. Currently forex inflows from FDI and FPIs may be muted but given that forex assets have been the major mover of M3 in the economy, the focus could quickly change to containing liquidity than enhancing it if FX flows become large and inflation rears its head again.

The RBI’s estimate for GDP growth during 2025-26 at 6.5% looks reasonable in the light of the actual performance. It believes the domestic growth drivers are in good fettle and that global uncertainties pose the downside risks.  But going back to its monetary policy-can-do-only-so-much stance, the RBI also seems to be pointing to the limitations of a bank credit-fuelled growth.

Personal credit growth still remains the key

While the RBI does not explicitly acknowledge the role of factors other than the cost of credit in the sluggishness of private capex investment, data on capital formation clearly show that households and informal sectors were taking the lead in investment. Much of capital formation now is in form of homes, buildings, roads and not plant and machinery or capital assets.

Given these trends, personal credit will still be the key to a credit boom if it happens, especially after the RBI backtracked on some of the tough regulatory measures that had stymied gold loans and lending to NBFCs earlier. But all of this depends on how much and how quickly rate cuts transmit through the credit system, which remains a moot question.