RBI Could Cut Repo Rate for the First Time in Five Years

Why in News?

The Reserve Bank of India (RBI) is expected to cut the repo rate by 25 basis points (bps) for the first time in nearly five years during the upcoming Monetary Policy Committee (MPC) meeting scheduled between February 5 and 7, 2025. The repo rate—the interest rate at which the RBI lends to commercial banks—has remained unchanged for the past two years. If implemented, this cut would mark the first major monetary policy move under RBI Governor Sanjay Malhotra, who took office in December 2024.

The expected cut is attributed to declining inflation, a slowdown in economic growth, and global uncertainties triggered by trade wars and fluctuating currency markets. The decision is likely to impact borrowing rates, investments, and overall economic growth, making it a crucial financial development.

Introduction

Monetary policy plays a crucial role in regulating economic growth, inflation, and liquidity in the financial system. The repo rate, as set by the RBI, determines the interest rates at which banks borrow money from the central bank, influencing lending rates for businesses and consumers.

Since May 2022, the RBI had increased the repo rate by 250 basis points (2.5%), bringing it to 6.5% in order to combat inflation. However, with consumer inflation falling, economic growth slowing, and uncertainties in global trade, policymakers are considering an interest rate cut to boost credit availability and economic activity.

The RBI’s decision will have a significant impact on businesses, homebuyers, and investors, as loan EMIs (equated monthly installments) could become cheaper, encouraging spending and investment in the economy.

Point-Wise Summary

1. Impending Repo Rate Cut

• The RBI is expected to reduce the repo rate by 25 basis points (bps), bringing it down from 6.5% to 6.25%.
• A basis point (bp) is one-hundredth of a percentage point.
• This would be the first repo rate cut since 2020 and the first major monetary policy move under new RBI Governor Sanjay Malhotra.

2. Reasons for the Expected Rate Cut

• Declining Inflation: The consumer price index (CPI) inflation fell to 5.22% in December 2024, down from 5.48% in the previous month.
• Slow Economic Growth: India’s GDP growth forecast was revised down to 6.6% for FY2025, compared to an earlier projection of 7.2%.
• Monetary Policy Alignment: Central banks in other economies have also signaled rate cuts due to slowing growth.

3. Impact of the Union Budget on Rate Cut Expectations

• The Union Budget 2025-26 introduced cuts in personal income tax and tax deduction at source (TDS) to increase disposable income.
• The budget aims to spur consumption and economic growth, making a rate cut supportive of this policy.

4. Potential Rate Cut Cycle

• Economists predict two successive repo rate cuts between February and April 2025, totaling 75 basis points.
• The next rate cut may happen in October 2025, depending on economic conditions.

5. Global Context and Impact of Trade Wars

• Trade tensions have escalated due to tariffs imposed by the US on Canada, Mexico, and China.
• This has led to dollar appreciation and a decline in global currencies, including the Indian Rupee.
• Rupee fell below ₹87 per US dollar, adding pressure on monetary policy.
• RBI has already implemented liquidity-enhancing measures, including a $5 billion forex swap and open market operations.

6. Potential Impact of Repo Rate Cut

• Lower Borrowing Costs: Banks may reduce lending rates, making home loans, car loans, and business loans cheaper.
• Lower EMI Payments: Borrowers will pay less on their loan installments, boosting disposable income.
• Boost to Business Investments: Lower interest rates encourage businesses to take new loans for expansion.
• Stock Market Reaction: A rate cut generally boosts investor confidence and may lead to a rise in stock markets.

7. Market Lending Rates and Repo Rate Relationship

• Since May 2022, the repo rate was increased by 250 bps, pushing up bank lending rates.
• The external benchmark lending rate (EBLR) has increased by 225 bps since May 2022.
• The one-year marginal cost of fund-based lending rate (MCLR) has risen by 175 bps in the same period.
• With the repo rate likely to fall, lending rates could be adjusted downward, benefiting borrowers.

8. Policy Measures Already Taken by the RBI

• Last week, the RBI introduced three liquidity-enhancing measures:
  • $5 billion forex swap to stabilize the Rupee.
  • ₹60,000 crore worth of open market operations to inject liquidity.
  • ₹50,000 crore worth of variable-rate repo operations to further ease liquidity.

Key Terms and Their Explanation

1. Repo Rate

• The interest rate at which RBI lends money to commercial banks.
• A reduction in the repo rate lowers borrowing costs across the economy.

2. Basis Points (bps)

• One basis point (bp) is equal to 0.01%.
• Example: A 25 bps cut means a 0.25% reduction in interest rates.

3. Monetary Policy Committee (MPC)

• The six-member body within the RBI responsible for setting interest rates.
• Decisions are based on inflation, economic growth, and global financial stability.

4. Consumer Price Index (CPI) Inflation

• Measures the average change in retail prices of goods and services over time.
• CPI inflation fell to 5.22%, influencing the rate cut decision.

5. External Benchmark Lending Rate (EBLR)

• The interest rate banks use for lending, linked directly to the RBI’s repo rate.
• A repo rate cut reduces EBLR, making loans cheaper.

6. Marginal Cost of Funds-Based Lending Rate (MCLR)

• Another benchmark for loan interest rates, affected by the cost of funds for banks.
• A repo rate cut may lead to lower MCLR, reducing borrowing costs.

7. Forex Swap

• A financial tool where RBI buys or sells foreign currency to stabilize the rupee.
• The recent $5 billion forex swap was done to manage currency volatility.

Conclusion

The expected repo rate cut of 25 bps will be a significant monetary policy move, aimed at stimulating growth amid declining inflation and global economic uncertainties. This decision will impact borrowers, investors, and businesses by making loans cheaper and increasing liquidity in the financial system.

Key Takeaways:

1. First repo rate cut in nearly 5 years, likely to bring it down to 6.25%.
2. Falling inflation (5.22%) and slowing GDP growth (6.6%) are key reasons.
3. Global trade tensions, rupee depreciation, and RBI’s liquidity measures are influencing policy.
4. Lower lending rates will benefit homebuyers, businesses, and consumers.

Stock markets may react positively due to improved liquidity and credit availability.