Anticipating the RBI’s Next Move: A 25 bps Rate Cut Under New Leadership
As the Reserve Bank of India (RBI) prepares to unveil its latest policy decision tomorrow, markets and economists are bracing for a potential 25 basis points (bps) rate cut. This anticipated move comes under the stewardship of the new RBI Governor, Sanjay Malhotra, whose approach to monetary policy will be closely scrutinized for indications of the central bank’s future trajectory.
The expectation of a rate cut is grounded in a combination of domestic economic indicators and global trends. India’s GDP growth has shown signs of moderation in recent quarters, with industrial output and private consumption exhibiting uneven momentum. Inflation, a perennial concern for the RBI, has recently remained within the central bank’s target range, providing room for a more accommodative stance.
Historically, the RBI has balanced the dual mandates of controlling inflation and supporting growth. Under previous governors, rate adjustments have often been influenced by external factors such as global commodity prices, currency volatility, and the monetary policies of major central banks like the Federal Reserve. The current global environment, characterized by slowing economic growth and easing inflationary pressures, aligns with a more dovish monetary policy approach.
Governor Malhotra’s leadership marks a pivotal moment for the RBI. His inaugural policy decision will set the tone for his tenure, offering insights into his priorities and policy framework. A 25 bps rate cut would signal a proactive stance towards stimulating economic activity, particularly in sectors that have been slow to recover post-pandemic.
However, risks remain. The RBI must tread carefully to avoid stoking inflationary pressures, especially given potential supply-side shocks and geopolitical uncertainties that could impact commodity prices. Moreover, the central bank’s communication strategy will be critical in managing market expectations and ensuring financial stability.
In conclusion, while a 25 bps rate cut appears likely, the broader implications of tomorrow’s policy outcome will hinge on the RBI’s forward guidance. Governor Malhotra’s debut policy decision is not just about the rate cut—it’s about the message it sends regarding the future direction of India’s monetary policy.
Expert Insights: Madhavi Arora, Emkay Global Finance
While a conventional 25bps rate cut in the upcoming MPC policy is less of a market debate, the actions around ‘what beyond a cut’ will be more watched. Easing by stealth via unconventional policy tools like liquidity and regulatory measures will continue. The RBI may also want to address the stress in the non-sovereign money market. We expect another round of approximately Rs300 billion OMOs, implying over Rs900 billion in total for FY25E. A CRR cut is a close call, but a temporary cut may not address the underlying banking stress. Easing in ensuing tighter LCR norms (effective from April 2025) and lending standards might be preferred policy tools. Additionally, we will watch for further capital account easing actions via the FCNR route.
Policy trade-offs are turning less challenging, and the RBI’s rate cycle is expected to commence with a 25bps cut. Underlying growth remains tepid with downside risks to the NSO’s advance GDP estimate of 6.4% for FY25 (RBI projects 6.6%). We estimate FY25 growth at 6%, with only mild improvement expected in FY26. While some sequential growth gains are visible, we are far from a sustained growth trajectory, and limited fiscal policy levers constrain the prospects of a turnaround.
Inflation concerns are easing, as noisy food inflation drove much of the headline figures in FY25, while core inflation remained subdued due to demand slack. Near-term food price pressures appear to be abating with broad-based easing across categories, and January 2025 inflation tracking below 4.5% (compared to 5.2% in December). We expect Q4FY25 headline inflation to ease to 4.4% from 5.6% in Q3FY25, supported by strong Kharif output. For FY26, average inflation is likely to ease further to around 4.5% compared to 4.8%-4.9% in FY25. Moreover, concerns that a consumption-focused budget could stoke inflation seem unfounded.
There is also a perceptible change in the RBI’s INR management stance. The fluid global dynamics influence the RBI’s approach, especially with mounting pressures on the INR. Despite recent fluctuations in the dollar and emerging market currencies, the RBI has become more judicious in its INR defense following aggressive interventions in Q3FY25, totaling over USD110 billion in spot and forward markets. We believe the policy trilemma could shift towards allowing the INR to find its equilibrium, providing greater policy flexibility for interest rate decisions. Recent dollar weakness has offered some breathing room for emerging market currencies, potentially giving the RBI more space for monetary easing.
Recent RBI measures since December 2024 mark the beginning of easing by stealth, a trend we expect to continue. The normalization of the CRR to 4.0% in December added over Rs1 trillion in liquidity, followed by measures in January 2025 that injected an additional Rs1.5 trillion. Despite these efforts, system liquidity deficits could remain high, around Rs2.5-2.8 trillion by the end of FY25, with a core deficit of Rs1.1-1.3 trillion. This suggests that further measures, such as additional OMOs, VRRs, and FX swaps, will be necessary. We anticipate further OMO purchases of approximately Rs300 billion, bringing total net OMOs to over Rs900 billion in FY25. Additional capital account measures to enhance the attractiveness of the FCNR deposit scheme are also expected.
While a CRR cut remains a close call, the RBI may find it insufficient to address the structural issues in deposit creation. Non-sovereign money market instruments, such as CDs and CPs, have not seen the same easing as sovereign G-secs, partly due to short-term liquidity constraints and deposit shortages. Although a temporary CRR cut could provide some relief, easing tighter LCR norms and regulatory lending standards might be more effective in boosting credit offtake and supporting deposit growth.