Opinion RBI signals inflation is under control. But will its latest rate cut spur corporates and households to spend more?

So, what are the takeaways from the RBI’s moves? The RBI has unabashedly turned pro-growth for now — and this may also seem like an acknowledgement of GDP growth weakness and the cloudy outlook due to global uncertainties. Moreover, the Governor averred that the central bank has been able to attain a victory over inflation for the time being. The RBI has opportunistically — and rightly so — chosen to use the space opened up by the low expected inflation trajectory to front-load its rate cuts, instead of spreading them over two policy meetings with cuts of 25 bps each. The CPI inflation prints are likely to hit sub-3 per cent in the next few months, thanks also to a favourable statistical base and improved supplies.

Importantly, in what must be one of the quickest reversals in monetary policy stance, the RBI changed its stance back to “Neutral” from “Accommodative”, announced in its April policy. The repo rate was around current levels only during the pandemic and in August 2019, and even the CRR has not been lowered to 3 per cent outside of the pandemic or a crisis. This is a clear signal that the RBI has concluded this rate cut cycle and will most likely remain on a prolonged pause, subject to evolving economic conditions.

A few important questions remain. First, will this rate cut boost GDP growth and spur consumption and capex? Monetary policy works with lags and, assuming transmission by lenders, the fuller benefits may accrue in the year 2026. While the RBI has been on an overdrive to address the supply side of credit — cutting policy rates, infusing durable liquidity — the demand for credit remains a problem. Corporates remain flush with cash and, with their balance sheet strength, have the ability to tap market instruments rather than banks if they need funds. However, with huge global uncertainties and still iffy domestic demand, they may not be inclined to borrow to undertake big investments.
As for households and consumption in general, the sentiment remains weak — in part due to the tepid wage growth cycle and the over-leveraging of the past. However, discretionary consumption segments, especially the high-ticket segments such as real estate and consumer durables or users of loaned funds, NBFCs (non-banking financial companies), will be among the immediate beneficiaries. While the RBI’s aggressive moves are expected to support real GDP growth, nominal GDP growth is likely to remain subdued due to muted retail and wholesale inflation. This may weigh on top-line growth for corporates.

Second, will lenders lower rates and transmit the rate cuts? With low organic demand for credit, most lenders are likely to adopt a wait-and-watch approach. Also, given the huge liquidity boost and the fact that around 60 per cent of the loans are linked to external benchmark-based lending rates (EBLR), one can expect lending rates to soften by 25–50 bps broadly over the next few quarters. While the repo rate cut may hurt the NIMs (net interest margins) of lenders, the CRR cut could act as a cushion, providing 7 bps relief, according to the RBI. The CD (certificates of deposit) and CP (commercial paper) markets are already beginning to see easing of yields, though this may not be so visible in the long end of the curve or in the 10-year yields.

Third, from an external economy perspective, the repo rate — now lower by 100 bps at 5.5 per cent — while the US Fed remains on a pause, will reduce the interest rate differential. This could weigh on capital inflows in a volatile world and also put downward pressure on the Indian Rupee.

Finally, why should the RBI have cut the CRR to 3 per cent — the floor mandated by current regulations — if liquidity was abundant, leaving the RBI with little ammunition in case of a global crisis?

Clearly, the RBI is not banking on “nudges” to the system and is counting on the money multiplier — in the backdrop of a larger monetary base and a huge liquidity gush — to shoulder probably a little more than its fair share of the responsibility of supporting growth.

The writer is Group Chief Economist, L&T. Views are personal