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The Reserve Bank of India's (RBI) Monetary Policy Committee (MPC) concluded its first policy meet of 2025 on January 7th, with a widely anticipated rate cut expected. This marks the first cut in nearly five years, following a period of seven rate hikes that culminated in a 6.50 percent repo rate. The pause since February 2023 is ending, driven by several key factors analyzed by economists and financial experts.
The prevailing opinion suggests a 25 basis points (bps) cut, marking the first monetary policy review for the newly appointed RBI Governor, Sanjay Malhotra. While his views on inflation and currency management remain somewhat opaque due to a lack of public statements since his December appointment, reports suggest a preference for a more hands-off approach to the rupee's value, allowing it greater freedom in line with regional peers. This contrasts with the strategies of his predecessor. However, there is a counter-argument that such a rate cut might be premature given present economic conditions.
Arguments in favor of the rate cut center on sluggish economic growth, government initiatives to boost liquidity (including recent injections of Rs 1.5 lakh crore and Rs 1.16 lakh crore into the banking system), and the government's fiscal prudence reflected in the recently announced Union Budget. These factors collectively suggest a strong case for lower interest rates. Nevertheless, challenges remain. Inflation persists above the RBI's medium-term target of 4 percent, and global uncertainties pose significant risks. The precise timing of the cut remains debated, with some suggesting a delay until the April policy review to assess the evolving situation more thoroughly.
Since the last MPC meeting in December 2024, several significant changes have influenced the current decision-making process. Most notably, increased volatility in major asset classes, especially the Indian Rupee (INR), has created a more complex landscape. Dipanwita Mazumdar, Economist at Bank of Baroda, highlights a “trilemma” facing the RBI: tighter liquidity conditions, a depreciating INR, and heightened geopolitical uncertainty. These risks were less pronounced in the previous policy review, which focused on concerns about missing growth forecasts and transient inflation risks.
The tightening liquidity situation, evident in a January 2025 durable liquidity deficit of Rs 40,000 crore, necessitates measures to restore surplus liquidity. The weakening INR, exacerbated by factors such as a strengthening US dollar (DXY), firmer US 10-year yields, and increased trade tensions (particularly with the return of Donald Trump to power and subsequent tariff increases), further complicates the situation. While typically volatility might suggest maintaining rates, the sharp decline in the INR value necessitates consideration of a rate cut to curb the outflow of domestic liquidity. Geopolitical uncertainty, stemming largely from the potential for escalating trade wars, introduces further downside risks to growth, supporting the argument for a rate cut to bolster the economy.
Despite these challenges, moderating inflation (supported by softening global commodity prices, particularly food prices) provides the RBI with some leeway to lower interest rates. Bank of Baroda's internal economic indicator also shows considerable moderation in inflation, tracking around 4 percent. The Bank of Baroda concludes that a 25 bps rate cut is warranted, and that a cumulative cut of around 50-75 bps throughout the rate cycle is feasible. The beginning of a shallower rate cycle therefore seems strategically appropriate given the current economic and geopolitical conditions. The need to support growth, while managing inflation and leveraging the government's fiscal consolidation efforts, underpins the overall rationale for the anticipated rate cut.
Source: RBI MPC meet: What has changed since last MPC meet? Why a 25 bps cut seems imminent?