The RBI monetary policy committee's June 6 decision to cut the repo rate by 50 basis points (bps) came as a surprise. Most economists and market analysts expected a 25 bps cut, which was pretty much priced in by the bond market, but the MPC surprised with a bumper combo of a 50 bps repo rate cut + 100 bps CRR cut.
The rationale given by RBI governor Sanjay Malhotra for the double booster is that the RBI is pretty much comfortable with the current CPI inflation trajectory, which continues to be benign and falling, while domestic growth needs monetary policy support. Strong macro fundamentals and lower inflation provided space to support growth.
The RBI left growth outlook for FY26 unchanged at 6.5 percent. It expects strong growth in agriculture and rural demand and the services sector. It expects urban demand to improve gradually.
Industrial activity has been lagging but expected to pick up and investment activity will pick up with easing financial conditions, improving business optimism and high capacity utilisation along with the government’s focus on capex.
What tilted the inflation-growth dynamic was the RBI’s inflation forecast. Over the last couple of policies, the RBI has reduced its CPI forecasts.
For FY26, CPI outlook was cut from 4.2 percent (February) to 4.0 percent (April) and now further to 3.7 percent (June policy). Much of this reduction has been in the near-term quarters, with Q1/Q2 CPI forecasts being reduced from 4.5 percent/4 percent (February policy) to 3.6 percent/3.9 percent (April policy) and now further to 2.9 percent/3.4 percent (June policy).
The CPI print slipped to a 69-month low in April, primarily on easing food prices, which has fallen for six straight months.
Core inflation has been contained, while fuel inflation has shown a slight uptick. Overall, the outlook on food inflation is benign, with comfortable supply and an expected good monsoon.
On the liquidity front, the RBI delivered the second surprise, with a 100 bps cash reserve ration cut, taking CRR prospectively to 3 percent from 4 percent in four equal traches between September and November of this year.
This CRR cut is expected to release a total of Rs 2.5 lakh crore of liquidity into the banking system.
The RBI has already been injecting durable liquidity into the banking system through a slew of measures – Variable Rate Repo (VRR) auctions, Open Market Operations (OMOs) and dollar-rupee buy-sell swaps, taking the system liquidity into surplus over the past three months.
The governor reiterated the RBI’s commitment to providing sufficient liquidity. The RBI’s decision to cut CRR is aimed at reducing the cost of funding of the banks, thereby helping in monetary policy transmission to the credit market.
Another significant announcement, though on the flip side, was the change in the policy stance from “accommodative” to “neutral”. The governor said given the quick rate cuts (cumulative 100 bps) delivered across three successive policies, there is little room left with the MPC for further easing.
Outlook
The overall policy announcement was definitely a pro-growth one, with the MPC deciding to upfront its rate actions (along with liquidity boosting measures) rather than staggering them over the year. Inflation outlook remains comfortable despite the possibility of the early/unseasonal rains creating some intermittent pressures on food prices.
The RBI governor has delivered some strong messages:
> while price stability remains the focus of monetary policy, the MPC is more inclined to adopt a pro-growth approach
> comfortable outlook around inflation but some concerns around growth
> though it has left the growth forecasts unchanged, the decision to deliver the bumper rate cut suggests some uncertainty in the MPC’s regarding the growth outlook, possibly due to spillovers from global geo-political tensions and trade tariff issues, besides the sluggish recovery in domestic demand
> commitment to providing sufficient liquidity and a focus on improving the transmission and credit growth by delivering the bumper 100 bps CRR cut
> a likely pause in/end to the rate cut cycle
We think the rate cut cycle has drawn to a close, with the change of the policy stance to "neutral". The terminal rate, which was anyway widely expected to be 5.5 percent, has been reached already, and it should stay here until the end of CY25, unless the global macro situation worsens, causing more damage to growth, which is not the base case.
Going forward, the RBI’s policy announcements are likely to be data-dependent, including its own tweaks to the inflation and growth forecasts. Given that adequate liquidity measures are already in place, the need to provide too much liquidity under the LAF (liquidity adjustment facility) window may incrementally reduce, and the RBI will be more guided by the evolving transmission and credit growth trends.
With the sharp rate cut, the CRR cut and comfortable liquidity conditions, the yield curve is likely to see the much-awaited steepening, with a drop in short term interest rates over the next few weeks.
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