RBI pivots finally, but delays softening the liquidity stance amid global headwinds

Unmesh Kulkarni is the Managing Director Senior Advisor at Julius Baer India

By Unmesh Kulkarni, Managing Director Senior Advisor at Julius Baer India

The RBI delivered the 'long-awaited' rate cut finally, the first in five years, by reducing policy rates by 25 bps, which was in line with market expectations. Markets had been clamouring for a rate cut over the last couple of policies, when several global central banks had already been cutting rates. However, RBI’s previous MPC had held back a rate cut owing to the evolving global uncertainties – Trump tariffs, capital outflows, pressure on the Rupee and, dollar sales by RBI, all of them negatively affecting the liquidity.

The MPC (Monetary Policy Committee) however kept the policy stance unchanged at 'neutral', a decision that might disappoint some sections of the market, which had started speculating on an additional CRR (cash reserve ratio) cut.

The Governor in his speech has hinted at a more flexible policy approach towards inflation-targeting framework, by taking a more ‘forward-looking’ approach with respect to inflation, rather than waiting for the headline CPI to reach 4%.

The MPC expects inflation to recede from the current levels of 4.8% (FY25 projection) to 3.8-4% for Q2-Q3FY26 and average at around 4.2% for FY26. The drop in inflation would be driven primarily by a fall in food prices aided by good kharif production and favorable rabi crop prospects. However, the MPC acknowledges that rising uncertainties in global markets, adverse weather events and volatility in energy prices present intermittent risks to its inflation forecasts.

The MPC is also acknowledging that growth has slowed down from 8.2% in the previous year to (its currently estimated) 6.4% for the current year. After slashing its quarterly growth forecasts in the December policy, the MPC has further reduced its forecasts in the February policy, estimating Q1 and Q2FY26 growth at 6.7% and 7.0% respectively, (down from earlier estimated 6.9% and 7.3%), and FY26 at 6.7%.

The MPC has taken a view that a less-restrictive monetary policy is more appropriate at the current juncture, and the growth-inflation dynamics has opened up space to support growth (through the rate cut), while staying focused on aligning inflation with the target on a durable basis.

On the liquidity front, the MPC is keeping a close watch on the evolving liquidity in the banking system, which dropped into deficit during December 2024 and January 2025 due to various factors – advance tax payments, capital market volatility and FPI outflows, dollar sales by RBI and an increase in currency in circulation. The Governor emphasized that the MPC remains committed to ensure orderly liquidity conditions, as is evident from the measures that the RBI has already announced in the recent weeks.

Read More: MPC impact on stock markets: Key takeaways on rates, growth, risks

Outlook

The rate pivot by the MPC is a welcome measure, which will give markets some confidence that the RBI is also committed to supporting growth, which has been declining sequentially, and the RBI’s own forecasts also acknowledging the decline in growth. While the focus remains steadfast on aligning inflation within the desired range, it is reassuring to see some flexibility being adopted by the MPC by making its rate decision ‘forward-looking’ rather than waiting to achieve the intended 4% headline CPI level.

The MPC will take a decision in each of its future meetings based on a fresh assessment of the macroeconomic outlook. However, given that the gates have opened to aligning policy with a more benign inflation-growth dynamic, we can expect a follow-though 25 bps rate cut in April policy.

We need to also monitor the evolving liquidity situation, which is dependent on multiple factors. A reduction in the liquidity deficit augurs well for a 25 bps rate cut in April, but if the banking system liquidity remains tight, the MPC might want to give April a skip. The regulator may not want to waste its key policy tool by making it ineffective.

Read More: Economists hopeful of an easing cycle after RBI’s first rate cut in five years

In any case, despite the slowing growth, given that we are still looking at 6.5-6.7% real GDP growth, the current rate cut cycle is likely to be shallow and limited to 50 bps, with the possibility of an additional 25 bps in H2FY26 in case growth falters beyond the MPC’s assessment.