RBI Cuts Repo Rate

Context:

The Reserve Bank of India (RBI) cut the policy repo rate by 25 basis points to 6.25%, the first cut in almost five years, driven by weakening inflation and slowing economic growth. Key takeaways from the policy announcement, its economic implications, and the market reaction are as follows:

Key Takes of the RBI Verdict

• MPC Decision
  • Repo Rate Cut: From 6.5% to 6.25%.
  • Unanimity: Six members voted for it in the MPC.
  • Policy Orientation: Maintained a neutral stance while capping its monetary policy less tight.

Why Rate Cut?

• Inflation is Coming in Analysed Moderation
  • Headline inflation had risen above 5% in recent months, but would begin to ease back. RBI reduced its inflation projection for Q4 FY26 to 4.2%.
• Economical Growth Slowing
  • India had slipped to growth of 5.4% in Q2FY25; this did weigh on space for policy to maneuver.
  • Forecasts for Growth in FY25 reduced further to 6.4 % (previous forecast was of 6.6% released in December).
• RBI is optimistic about 7%+ growth potential.

Key Regulatory Announcements

• Liquidity Coverage Ratio (LCR) and Project Finance Norms
  • The Liquidity Coverage Ratio (LCR) is a metric that measures a bank’s ability to meet its short-term obligations. It’s calculated by dividing a bank’s high-quality liquid assets (HQLA) by its total net cash outflows over a 30-day period. The LCR must be at least 100%. 
  • The above was originally to be effective from 2025, has now been shifted to 31 March 2026.
• Expected Credit Loss (ECL) Framework
  • Expected Credit Loss (ECL) is a method for estimating the amount of financial losses a company or financial institution may incur due to a customer’s default or non-payment. ECL is a probability-weighted estimate of the potential losses that may occur on a loan or portfolio of loans. 
  • Its implementation has also been shifted to 31 March 2026.
• Retail Loans
  • RBI has been pleased with the moderation in unsecured retail loan growth.
• Regulatory Measures
  • “Cease and desist” orders will be used only in the rarest of rare cases.

Rate Cut Implications

• Banking & Loans
  • Direct Effect: About 40% of loans with an external benchmark interest rates shall be reduced.
  • Lags in transmission: Rates of deposit and MCLR linked loans will take at least two quarters to absorb.
• Inflation & Growth Forecast
  • Inflation: It will soften, with FY26 estimates at 4.2%.
  • Growth: RBI projects GDP back to growth but recognizes FY25 growth will be lower than FY24.
  • Tax Incentives: Assures that the govt’s tax sops will not be inflationary.
• Market Reaction
  • Stock Market Response:
    • Sensex ended down 198 points ( 0.3%) at 77,860.
    • Nifty closed 43 points lower ( 0.2%) at 23,560
      • Though it lost, both indices showed weekly gain (Sensex: +0.46%, Nifty: +0.33%).
• Forex Market
  • RBI intervened by selling dollars to stabilize the rupee.
  • Rupee has initially strengthened at ₹87.32/USD, but settled at ₹87.43/USD.

The RBI is actually playing the game of juggling between supporting growth and containing inflation. In doing so, however, the market reaction to the move remains muted in that the market has priced the move, or is careful on future uncertainties regarding the economy. The central bank remains bullish about India’s long term 7%+ growth potential, nonetheless, challenges related to growth are persistent over the near term.

Source: Business Standard