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In the days following the first MPC meeting for 2025-26 which concluded on April 9, 2025, it was widely expected that another policy rate cut of at least 25 basis points would happen in the second meeting to be held on June 4-6, 2025. But as the day drew closer, a good number of market participants, analysts and observers veered around to the view that a 50-basis point cut was in the offing. They have proved right. The MPC cut the policy repo rate in this meeting by 50 basis points to 5.50 per cent by a majority of 5-1. The lone dissenting MPC member favoured a cut by 25 basis points. The cumulative rate cuts so far since the start of the current policy easing cycle in February this year is 100 basis points.
Monetary easing can add to growth, but only in a cyclical sense
The MPC cited softening inflation, and the need to support private consumption and investment as key reasons for front-loading the rate cut. And the change in stance indicated limited space for further policy easing. Also, it seems that the policy measures are also intended to provide some counter-balance to the headwinds arising out of global uncertainties.
Banks will not lower their deposit rates in a hurry, particularly if they believe that the quick shift to a neutral stance means a good likelihood of a speedy end to the current easing cycle
The financial markets expressed glee over the policy announcements in one voice, as it were, with the SENSEX gaining about 700 points in the immediate aftermath. The banking stocks went even higher, with NIFTY Bank index going up by over 800 points. The price of 10-year G-Sec also rose.
Inflation and growth outlook
The headline CPI inflation for 2025-26 is now projected at 3.7 per cent, revised lower from the earlier forecast of 4 per cent made in April 2025. This outlook assumes a normal monsoon and is supported by moderating food inflation, contained core inflation, and softening global commodity prices.
MPC goes for an aggressive 50 bps rate cut to support consumption and growth
The real GDP growth forecast for 2025-26 has been maintained at 6.5 per cent. This is based on sustained momentum in private consumption, investment, and services sector activity, despite global uncertainties.
‘Everything, all at once’ policy response?
Monthly headline CPI inflation since February this year remained below the 4 per cent target by progressively wider margins, with the print for April falling to a six-year low of 3.2 per cent. Food inflation mirrored the same trend albeit at a faster pace and core inflation too behaved well during this period, thereby reinforcing a benign inflation outlook for the near future. This is no mean achievement for the RBI and its MPC, particularly when seen against the fact that only a few years back, the MPC had to explain its failure to keep headline inflation below 6 per cent, the upper end of the (4+/- 2) per cent band.
Monthly headline CPI inflation since February this year remained below the 4 per cent target
However, the well-earned confidence of the RBI notwithstanding, the decision to switch to a neutral stance by frontloading a 50 basis points cut seems a bit unusual, especially if there is no further cut in the policy rate in this easing cycle. It would be useful to view this in the context of two other related developments: First, very aggressive moves since the beginning of 2025 for the infusion of a huge amount of durable liquidity, totalling about Rs. 9.5 lakh crores, using all the toolkits available which turned the banking system liquidity from a significant deficit to a comfortable surplus position.
Second, a steep 100 basis point slashing of the CRR from 4 per cent to 3 per cent in four tranches announced alongside the policy rate cut which would release an estimated Rs. 2.5 lakh crore of liquidity into the banking system.
The MPC cited softening inflation, and the need to support private consumption and investment as key reasons for front-loading the rate cut. And the change in stance indicated limited space for further policy easing
To give a perspective, a similar CRR cut happened in March, 2000 in the wake of the outbreak of Covid-19 in India. This CRR cut comes on the top of 50 basis points reduction in CRR announced in December last year. These measures are intended to reverse the declining trend in credit growth of banks and NBFCs observed in 2024-25 vis-à-vis the two previous fiscal years and also to enhance transmission of the monetary policy to the real economy through the balance sheets of banks and NBFCs.
To what extent the policy rate cut and CRR reduction will result in any noticeable reduction in the cost of funds of banks and NBFCs is something that will be observed keenly. As has always been the case, banks will not lower their deposit rates in a hurry, particularly if they believe that the quick shift to a neutral stance means a good likelihood of a speedy end to the current easing cycle.
The real GDP growth forecast for 2025-26 has been maintained at 6.5 per cent
There is no denying the fact that there exists now a confluence of favourable conditions to support the growth momentum of the Indian economic through monetary easing. But as has been established both theoretically and empirically, monetary easing can add to growth, but only in a cyclical sense. It is not helpful in achieving ‘aspirational’ growth, whatever that may mean. The monetary policy can smoothen cyclical variations in growth. However, more importantly, the monetary policy can boost the long-term growth potential of the economy by keeping inflation low and steady. And to be sure, there is no ‘fast track’ monetary policy.