RBI policy: Why is the MPC likely to cut the repo rate?

What is expected from the RBI’s upcoming monetary policy?

A majority of economists have pencilled in a 25 basis points (bps) reduction in the repo rate, to 6.25 per cent from 6.5 per cent. One basis point (bps) is one-hundredth of a percentage point. This would be the first monetary policy announcement by the new RBI Governor, Sanjay Malhotra.

“We do believe that a repo rate cut is on the cards soon, as the budget has done well to spur growth. And with expectations of inflation to come down, this could be the right time,” said Madan Sabnavis, Chief Economist, Bank of Baroda.

The Union Budget 2025-26 announced a cut in personal income tax and also revised the limits of the tax deducted at source (TDS). These measures would provide the much-needed stimulus to consumption demand.

Retail inflation or consumer price index (CPI) inflation eased to a four-month low of 5.22 per cent in December from 5.48 per cent in the previous month.

“We expect a 25-basis point rate cut in the February 2025 policy. Cumulative rate cuts over the cycle could be at least 75 basis points, with two successive rate cuts over February and April 2025,” said an economic report by State Bank of India (SBI).

With an intervening gap in June 2025, the second round of rate cuts could start from October 2025, the report said.

Sabnavis said the RBI has already announced liquidity enhancement measures that have improved conditions in the market. This appeared to be a prerequisite for cutting rates.

Last week, the RBI had announced three measures — $5 billion forex swap, Rs 60,000 crore of open market operations, and Rs 50,000 crore worth of 56-day variable day repo rate — to improve liquidity in the banking system.

Global trade wars impact

The policy will be announced amid global uncertainty, with US President Donald Trump announcing tariffs on Canada, Mexico and China. The tariffs on Canada and Mexico have been postponed for a month.

The tariffs triggered a fear of global trade wars, resulting in a rise in the dollar against major currencies on Monday. The rupee plunged below the 87-level to an all-time low of 87.29 per dollar on Monday.

“The puzzle is to manage rupee movements with liquidity because if dollars are sold, it will draw out liquidity. All eyes are on the RBI now for monetary action,” Sabnavis said.

What happens to lending rates if the repo rate is cut?

If RBI reduces the repo rate to 6.25 per cent from the existing 6.5 per cent, all external benchmark lending rates (EBLR) linked to the repo rate will come down by 25 bps, giving relief to borrowers as their equated monthly instalments (EMIs) will fall.

Lenders may also reduce interest rates on loans that are linked to the marginal cost of fund-based lending rate (MCLR), where the full transmission of a 250 bps hike in the repo rate between May 2022 and February 2023 has not happened.

In response to the 250 bps hike in the policy repo rate since May 2022, banks have revised upwards their repo-linked external benchmark-based lending rates (EBLRs) by a similar magnitude. The one-year median marginal cost of funds-based lending rate (MCLR) has increased by 175 bps during May 2022 to December 2024.

GDP growth forecast

Bank of Baroda’s Sabnavis expects some changes in the forecast on growth, as the National Statistics Office (NSO) had projected 6.4 per cent for the year.

“It would be interesting to see if RBI would provide a forecast for growth in FY26, though this normally is published in the April policy,” he said.

In the December 2024 monetary policy, the RBI had slashed the GDP growth estimate to 6.6 per cent for FY2025, from an earlier projection of 7.2 per cent.