Bibtex
Endnote
RIS
As widely expected, the MPC of RBI, on conclusion of its first bi-monthly meeting for 2025-26, lowered the policy repo rate by 25 basis points to 6 per cent and shifted the stance of the monetary policy from ‘neutral’ to ‘accommodative’. Both the decisions of the MPC were unanimous. Both equity and G-Sec prices fell marginally after the policy announcement.
Monetary policy transmission
In the wake of the first 25 basis point cut in the current easing cycle in the last bi-monthly meeting of the MPC in early February this year, a concern was raised whether adequate transmission of the policy cuts for lowering interest rate on loans, in general, could be achieved with the system liquidity being in huge deficit at that time: it reached a peak of Rs. 3.1 lakh crore on January 23, 2025.
The MPC’s shift in stance to ‘accommodative’ may be a signal for further rate cuts going ahead
Subsequently, the RBI injected system liquidity, using all the means at its disposal, viz. repo, forex swaps and bond purchase (OMO). Infusion of a cumulative Rs. 6.9 lakh crore of liquidity has brought the system liquidity to a surplus of Rs. 1.5 lakh crore on April 7, 2025. However, MCLR, which is linked to deposit rates has remained mostly unaltered because term deposit rates have not come down except for a few major banks. If anything, the weighted average domestic term deposit rate (WADTDR) reached a nine-year high of 7.02 per cent in February, 2025.
To be sure, apart from tight liquidity conditions, there were other forces at play in pushing the term deposit rates higher: Flight of retail term deposits to mutual funds in the recent period. The corresponding increase in current account deposits, and, hence, in the overall CASA segment was no cause for durable comfort to banks, since they were highly volatile, by their very nature.
The combined effect of a lower policy rate and turnaround in system liquidity has already been felt to some extent in the form of lower bulk deposit rates
In other words, there has been a structural reduction in the proportion of retail term deposits in the total deposits of banks, caused by a fall in the share of the stock of financial assets of households in bank deposits. Expectedly, the combined effect of a lower policy rate and turnaround in system liquidity has already been felt to some extent in the form of lower bulk deposit rates.
The upshot of the above is that reduction in the MCLR, even after a time lag, is likely to be lower than the cumulative policy easings that are likely to take place in 2025-26. As per some estimates, the funding costs of banks are unlikely to fall by more than 30-35 basis points for a cumulative policy rate easing of 75 basis points.
In the light of these developments, a slew of suggestions has been made to the authorities, that include re-introduction of the overnight fixed-rate repo, adoption of a new benchmark representing the Secured Overnight Rupee Rate (SORR), and further lowering of the Cash Reserve Ratio (CRR).
Concerted fiscal and monetary responses may be necessary to cushion the country’s economy in the uncertain times ahead
On April 8, 2025, i.e., when the MPC meeting was in in progress, the RBI announced the introduction of the overnight variable rate repo. One expects the FBIL to commence publication of SORR soon. But it is unlikely that SORR will replace weighted average call rate (WACR) as the operating target for monetary policy, because the liquidity operations of the RBI are able to influence only the most basic of all interest rates: the inter-bank overnight unsecured rate.
It is likely that in the days to come banks will have to contend with lower deposit and credit growth rates than hitherto, possibly veering around their long-term equilibrium i.e., nominal GDP growth rate. This will have implications for banks’ profit and profitability, among other things.
Where from here?
Keeping in view the change in the policy stance and its ‘guidance’ implications, it is highly probable that the policy rate will be reduced more in 2025-26 by another 50-75 basis points, provided that the CPI inflation does not deviate much from the trajectory projected by the MPC. By all indications, the growth impulses of the Indian economy began to show signs of weakness from the second half of the last fiscal.
Introduction of securitisation of stressed assets would supplement the activities of asset reconstruction companies (ARCs) in the loan resolution/recovery arena
It remains to be seen if the adverse impact of the steep import tariff increases by the US on India’s growth for 2025-26 is limited to 20 basis points vis-à-vis the earlier projection of 6.7 per cent of the RBI. As indicated by the RBI, there are many unknowns for India’s macroeconomic prospects that are associated with the resetting of the order for trades between nations that is seemingly underway now in the aftermath of the unilateral US action.
Concerted fiscal and monetary responses may be necessary to cushion the country’s economy in the uncertain times ahead, particularly if external demand falls drastically or global supply chains face serious disruption. Also, maintaining the stability of the financial sector will be crucial.
Enhancement in the ceiling amounts for UPI transactions is also a step in the right direction
All the six developmental/regulatory steps announced are timely and useful. Introduction of securitisation of stressed assets would supplement the activities of asset reconstruction companies (ARCs) in the loan resolution/recovery arena. Like in the case of standard assets, securitisation of NPAs will mean full risk transfer from the originator to the investors.
One expects that banks do not emerge as the largest class of investors, as in the case of security receipts issued by ARCs. The proposal to issue comprehensive guidelines for gold loans is also very timely and appropriate, as there have been instances of malpractice and flouting of regulatory norms by quite a few lenders. One expects the new guidelines to cover management of operational risks involved gold loans. Further, enhancement in the ceiling amounts for UPI transactions is also a step in the right direction.
Finally, the crisp and clear tone, reasoning and language of the monetary policy statements is noticeable. They bear the stamp of the new top leadership in the RBI.