Bibtex
Endnote
RIS
After keeping the status-quo of the policy repo rate at 6.50 per cent since April 2023, for as many as 10 consecutive bi-monthly cycles, the MPC has turned. The resolution dated February 07, 2025, unanimously decided on a policy repo rate cut by 25 bps against the background of challenging domestic and global macroeconomic developments.
The policy space arising out of the rate cut coupled with credit uptake and prudent fiscal operation would help in evolving positive growth-inflation dynamics
Data released by the National Statistical Office (NSO) shows that during the period April 2023 to December 2024, the inflation rate (measured in terms of Consumer Price Index – Combined) was below the 4 per cent mark only on two occasions i.e., July 2024 (3.60 per cent) and August 2024 (3.65 per cent). On three occasions, the inflation rate was above 6 per cent i.e., the upper limit under the flexible inflation targeting (FIT), viz. July 2023 (7.20 per cent), August 2023 (6.83 per cent) and October 2024 (6.21 per cent). Quarterly growth rate (measured in terms of GDP at constant prices) as per the NSO data was in the range of 7.8 per cent (Q4 2023-24) and 8.6 per cent (Q3 2023-24). During 2024-25, Q1 growth data was at 6.7 per cent.
Increasing tax buoyancy is critical and crucial for the elimination of the revenue deficit to ultimately promote growth given by the inflexibility of reducing revenue expenditure
However, it recorded a significant decline at 5.4 per cent in Q2 2024-25. The MPC for 2024-25 has projected an inflation rate of 4.8 per cent. Thus, the past monetary policy action of maintaining a status quo on the repo rate has helped moderating the inflation rate, while the growth rate is a matter of concern.
At the current juncture (2025-26), the global economy is growing at 3.3 per cent, which is below the historical average (2000-19) of 3.7 per cent. According to the World Economic Outlook IMF January 2025 update, the global median of sequential core inflation has been just slightly above 2 per cent for the past few months.
The world economic landscape remains challenging with a slower pace of disinflation, lingering geopolitical tensions and policy uncertainties. The strong dollar, inter alia, continues to strain emerging market currencies and enhance volatility in financial markets.
The budget should not have a revenue deficit and the government should not borrow to meet the revenue expenditure as is happening currently
Against the above global scenario, the MPC has projected economic growth rate at 6.7 per cent and inflation rate at 4.2 per cent, respectively, for 2025-26. Against the above backdrop, here is analysed the a) liquidity position, b) transmission of the rate cut to bank lending rate, c) credit uptake and d) policy space for fiscal operations.
The system liquidity has been in deficit for December 2024 and January 2025, resulting in injection of liquidity by the RBI. The trend has reversed in the first week of February with absorption of liquidity. For example, the net absorption of liquidity as on February 09, 2025, was Rs. 41,424 crores. Including this absorbed amount, the net outstanding liquidity injected amounted to Rs. 1,73,927.4 crores as on February 09, 2025.
Such higher injection/absorption comes in the way of a true reflection of weighted average call rate (WACR), which is the operating target of the monetary policy.
The total non-food credit as on January 17, 2025, on the financial year basis was 6.4 per cent and on y-o-y basis was 10.6 per cent. This shows the policy space of rate reduction needs to be translated to the credit uptake
In view of this, the RBI Governor has remarked in his statement of Feb. 07, 2025: “It has been observed that some banks are reluctant to onlend in the uncollateratised call money market; instead, they are passively parking funds with the Reserve Bank. We urge the banks to actively trade among themselves in the uncollateratised call money market to make it deeper and vibrant for better signal extraction from the weighted average call money rate (WACR).”
WACR being the operating target must be kept in alignment with the policy repo rate. According to the available data released by RBI weekly statistical supplement (WSS) for example, when the policy repo rate was 6.50 per cent, the WACR was 6.57 per cent. Similarly, when the policy repo rate was reduced to 6.25 per cent on February 07, 2025, the WACR was 6.26 per cent. Thus, both the rates are moving in sync with one another.
The world economic landscape remains challenging with a slower pace of disinflation, lingering geopolitical tensions and policy uncertainties
Furthermore, as mentioned in the Monetary Policy Report October 2024 of the RBI, the transmission of repo rate increased in the easing phase (February 2019 - March 2022), when the reduction of policy repo rate by 250 bps resulted in a reduction in lending rates on fresh loans by 232 bps and outstanding loans by 150 bps. Similarly, during the tightening phase (May 2022-February 2023), the increase in the policy repo rate by 250 bps resulted in an increase in lending rates by 190 bps in fresh loans and 119 bps in outstanding loans. Thus, the policy space in connection with the transmission mechanism as mentioned above is incomplete.
The credit uptake as may be seen from the gross deployment of credit released by RBI in the January Bulletin 2025 has been encouraging though at a subdued rate. For example, the total non-food credit as on January 17, 2025, on the financial year basis was 6.4 per cent and on y-o-y basis was 10.6 per cent. This shows the policy space of rate reduction needs to be translated to the credit uptake.
"We urge the banks to actively trade among themselves in the uncollateratised call money market to make it deeper and vibrant for better signal extraction from the weighted average call money rate"
Let us now turn to fiscal operation. The budget should not have a revenue deficit and the government should not borrow to meet the revenue expenditure as is happening currently. Furthermore, a revenue deficit of 1.5 percent of GDP as budgeted for 2025-26 reflects the dissaving of the government and has the potential to adversely impact economic growth. Therefore, the priority is to eliminate the deficit.
In this context, it is important to note that the income tax buoyancy of 1.30 for 2025-26 is lower than the average buoyancy of 1.74 recorded in the past five years ending 2023-24. Thus, increasing tax buoyancy is critical and crucial for the elimination of the revenue deficit to ultimately promote growth given by the inflexibility of reducing revenue expenditure.
The standard budgetary practice tends to place capital expenditure at a higher level in the budget estimates and subsequently reducing the same to a lower level to show a lower fiscal deficit to GDP ratio. This deviation is against prudent fiscal management and shows poor fiscal marksmanship. Illustratively, we may mention that this has happened during 2024-25 revised estimate where, effective capital expenditure (Expenditure in capital account plus grants in aid to state government for creation a capital asset) was reduced from Rs. 15,01,889 crores to Rs. 13,18,320 crores, a decline of 12.2 per cent.
The strong dollar, inter alia, continues to strain emerging market currencies and enhance volatility in financial markets
Therefore, the budget should keep the effective capital expenditure at Rs. 15,48,282 crores (as per the budget estimates), recording an increase of 17.4 per cent in 2025-26. This works out to 4.3 per cent of GDP. This will truly support economic growth.
To conclude, the policy space arising out of the rate cut coupled with credit uptake and prudent fiscal operation would help evolving growth-inflation dynamics in line with the objective of monetary policy, which quite simply is “maintaining price stability keeping in mind the objective of growth”.