The RBI is anticipated to reduce interest rates for the first time in almost five years.

 

The RBI is anticipated to reduce interest rates for the first time in almost five years.

The Reserve Bank of India (RBI) is expected to lower interest rates for the first time in almost five years this Friday, as concerns about persistent inflation ease, according to economists and investors surveyed by ET. The shift in focus at Mint Road is now on boosting a visibly slowing economy.

Nine out of the 12 financial institutions surveyed believe that the newly formed Monetary Policy Committee (MPC), which will convene for the first time since Governor Sanjay Malhotra took office in December, will vote to cut the repo rate—the rate at which the RBI lends to banks—by 25 basis points to 6.25%. Moreover, Saturday’s budget proposal, which includes a fiscal deficit of 4.4% of GDP for FY26, compared to the more favorable 4.8% for FY25, will further support the MPC’s decision.

A basis point represents one hundredth of a percentage point. This would mark the first rate cut since May 2020, when rates were lowered to mitigate the effects of the Covid-19 pandemic.

"Revenue expenditure as a percentage of GDP has decreased to 11% from 11.4%, which is fiscally prudent," said Gaura Sengupta, Chief Economist at IDFC First Bank. "So, from an MPC standpoint, the deficit numbers won’t impact the decision," she added.

Abhishek Upadhyay, Senior Economist for Fixed Income Strategy at ICICI Securities Primary Dealership, noted, "This is an ideal time to cut rates as inflation has moderated and is expected to continue easing. A rate cut would also enable the RBI to focus on managing growth."

However, three participants in the poll believe the RBI will not reduce rates.

The Reserve Bank of India (RBI) has been one of the few central banks not to reduce interest rates, even as other central banks, including the US Federal Reserve, started easing much earlier. This is due to persistently high domestic inflation, primarily driven by food prices. The Monetary Policy Committee (MPC) believed that cutting rates too soon would risk allowing inflation to stay elevated for an extended period. Inflation in December fell to 5.2% from 5.5% in November, while GDP growth for the September 2024 quarter slowed to 5.4%, with expectations of weak consumption and falling corporate profits.

The overnight index swap (OIS) rates are also reflecting expectations of a rate cut, with the 1-year OIS trading at 6.33% on January 31, according to CCIL data. The OIS market usually prices in a spread of about 25 basis points above the expected repo rate at a given time. Additionally, the RBI’s actions on liquidity, such as conducting numerous variable rate repo auctions and direct bond purchases to address a liquidity gap of up to ₹2.2 lakh crore, suggest the start of an easing cycle.

However, global factors are complicating the RBI’s policy response. The rupee has weakened by over 3% since November, trading at 86.6 per dollar. Efforts to sell US dollars to prevent a sharp depreciation have led to a liquidity drain, which the RBI is addressing through various measures. Some analysts believe this could mean the RBI might delay its first rate cut until April, when it would have a better grasp on liquidity and currency fluctuations.

"I believe we will see a rate cut in April, not during the February policy," said Rajeev Radhakrishnan, Chief Investment Officer for Fixed Income at SBI Mutual Fund. "The RBI needs to ensure adequate liquidity without stress. A rate cut now wouldn’t have the desired effect because rates wouldn’t be properly transmitted. We need conditions of easy, neutral, or surplus liquidity for effective transmission of rates."

Some investors anticipate that the RBI might reduce the Cash Reserve Ratio (CRR) again, as it did in December, which released ₹1.16 lakh crore into the system. However, doubts have been raised due to the other liquidity-boosting measures the RBI has already implemented. "It would be more appropriate for the RBI to first use other methods to infuse liquidity and then assess whether a CRR cut is necessary," Upadhyay explained.