In a unanimous decision, the Reserve Bank of India's (RBI) Monetary Policy Committee (MPC) has cut the repo rate by 25 basis points (bps), bringing it down from 6.50 percent to 6.25 percent. This marks the first repo rate reduction in almost five years, aimed at boosting economic activity by making borrowing more affordable, thereby encouraging spending and investment. With the repo rate cut, interest rates and equated monthly installments (EMIs) for home and personal loans are expected to decrease.
In a unanimous decision, the RBI’s Monetary Policy Committee (MPC) reduced the repo rate to stimulate economic activity by making borrowing more affordable, thus encouraging spending and investment. This move reflects the central bank’s response to changing economic conditions and its goal of supporting growth while controlling inflation. The committee has forecasted a GDP growth of 6.7 percent and retail inflation at 4.2 percent for the fiscal year 2025-26.
Why did RBI cut Repo rate?
The primary reason for the RBI's repo rate cut is to encourage economic growth by lowering borrowing costs for individuals and businesses, which should lead to more spending and investment. Since inflation remains within the RBI's target range, the rate reduction can help keep prices stable while promoting growth.
The rate cut can enable banks to lower their lending rates, making credit more affordable and accessible for borrowers. This, in turn, can encourage more borrowing, spending, and investment, which may lead to job creation and increased employment. Additionally, the reduction aligns India with global economic trends, as several central banks have embraced accommodative monetary policies. "The policy panel has observed the decline in inflation," said RBI Governor Sanjay Malhotra.
What’s the impact?
All external benchmark lending rates (EBLR) — lending rates set by the banks based on external benchmarks such as the repo rate — will come down by 25 bps, giving relief to borrowers as their equated monthly instalments (EMIs) will also fall. Lenders may also reduce interest rates on loans that are linked to the marginal cost of fund-based lending rate (MCLR, or the minimum lending rate below which a bank is not allowed to lend), where the full transmission of a 250-bps hike in the repo rate between May 2022 and February 2023 has not happened.
Following the 250-basis point increase in the policy repo rate since May 2022, banks have raised their repo-linked External Benchmark Lending Rates (EBLRs) by a similar amount. The one-year median Marginal Cost of Funds-based Lending Rate (MCLR) has risen by 175 basis points between May 2022 and December 2024.
The reduction in the repo rate will lower EMIs on home and vehicle loans, making it easier for individuals to manage their debt repayments. A cheaper borrowing rate can spur greater spending and investment, which helps stimulate economic growth. With lower interest rates, banks are more inclined to lend, increasing credit availability for consumers and businesses.
However, lowering the repo rate could also contribute to higher inflation, as a greater money supply and reduced borrowing costs might push up prices. Additionally, it may make saving less attractive due to reduced interest earned on deposits. It’s important to note that the RBI's decision to cut the repo rate is influenced by a range of factors, such as inflation, economic growth, and global economic conditions.
GDP Growth & Inflation Projections
RBI Governor stated that the central bank will continue using flexible inflation targeting to make optimal macroeconomic decisions. In its December 2024 monetary policy review, the RBI revised its GDP growth forecast for FY2025 to 6.6 percent, down from the earlier estimate of 7.2 percent. However, it now projects a GDP growth of 6.7 percent for FY2025-26.
"The Indian economy has experienced a slowdown in the current fiscal year, with consensus estimates now pegging GDP growth at 6.4 percent, down from 8.2 percent in FY24. While headline inflation has moderated to 5.2 percent in December 2024 and is expected to further decline to 4.5 percent in the coming months, there are concerns about its sustainability due to the rupee’s depreciation, touching 87 against the US dollar," said Suman Chowdhury, ED & Chief Economist at Acuité Ratings.
According to the First Advance Estimates released by the Ministry of Statistics and Programme Implementation, India's GDP growth estimate for FY2024-25 is 6.4 percent, slightly lower than the Economic Survey’s forecast of 6.5 percent to 7 percent growth.
Retail inflation is projected to be 4.2 percent in 2025-26, according to the RBI Governor. "We anticipate a significant moderation in headline retail inflation by January 2025, with inflation expected to fall within the range of 4.5-4.7 percent. The inflation outlook is largely aligning with estimates, with notable support coming from the decline in vegetable prices," Bank of Baroda stated in a report. Additionally, global edible oil prices have softened, which is expected to positively impact the domestic inflation trajectory.
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