RBI Monetary Policy: Feb 2025 New Governor ushers in a softer rate regime

The Monetary Policy Committee, led by the new Reserve Bank of India (RBI) Governor, has lowered the repo rate by 25 basis points to 6.25%—the first reduction in nearly five years. This decision highlights the RBI’s commitment to supporting growth, enhancing liquidity, and maintaining flexible inflation targeting. The rate cut was highly anticipated following the Union Budget that reduced income tax rates, boosting consumption. This move is likely to have a significant multiplier effect on consumption and economic growth. However, we believe that while growth may recover from its lows of Q2FY25, it will still be below last year’s numbers. Although the central bank’s stance remains neutral, it’s notable that all members unanimously voted for the rate cut, contrasting with the December policy where four members voted against a rate cut.

We view this rate cut as a positive development and had anticipated this move early on. Although the markets did expect further liquidity measures, the Governor has assured the markets that he will look both at durable and transient liquidity and pro-actively carry out measures when needed.

It is pertinent to note that end January, the RBI announced measures to boost liquidity in the system. These included Rs 60,000-crore Open Market Operations (OMO) purchase auctions of Government securities, a 56-day Variable Repo Rate (VRR) auction of र50,000 crore, and a $5-billion USD/rupee buy/sell swap auction for a six-month tenure. These measures could lead to liquidity infusion of about Rs 1.50 lakh crore in the banking system in a phased manner, beginning January 30 and ending on February 20 with OMO purchase auction. To ease liquidity tightness in the banking system, the RBI started conducting daily Variable Rate Repo (VRR) auctions with effect from January 16. These auctions will be conducted until further notice.

Additionally, considering the concerns of banks needing to allocate additional funds to meet the Liquidity Coverage Ratio (LCR) requirements, the RBI has postponed the implementation of the revised LCR norms until March 2026. This decision allows banks ample time to comply without experiencing liquidity disruptions.

Liquidity in deficit since December 2024

Repo rate cut while CRR unchanged

Policy Decision

• Repo rate lowered by 25 bps to 6.25%


• SDF rate now at 6.0% and MSF rate & bank rate at 6.5%


• CRR unchanged at 4%


• All members unanimously voted for an interest rate cut


• All members decided unanimously “to continue with the neutral stance and to remain unambiguously focused on durable alignment on inflation with the target while supporting growth”

Growth estimates cut while inflation projections lowered across periods

The MPC noted that GDP growth could be boosted to some extent following the Union Budget relief in income tax rates that will have a beneficial effect on consumption. Looking ahead, healthy rabi prospects and an expected recovery in industrial activity should support economic growth in FY26. The moderation in food inflation, as vegetable price inflation came off from its October high, drove the decline in headline inflation. Core inflation remained subdued across goods and services components and the fuel group continued to be in deflation. However, headwinds from geo-political uncertainties, rising commodity prices and financial market volatility could impact growth. Accordingly, the growth and inflation numbers have been revised as below.

Source: RBI Governor’s Statement dated 7^th February 2025

Market Reaction

The repo rate cut was on expected lines. Few sections of the markets expected additional measures on liquidity including further CRR cuts to ease liquidity in the banking system. Post the announcement, bond yields across the curve rose by 3-4 bps as rate cut was largely priced in. Similar movement was observed in Swaps.

Our View

Policy commentary is in line with our view. In our Acumen “Navigating Headwinds” we had predicted the RBI would introduce liquidity measures like VRR auctions, FX buy/sell swaps and/ or CRR cuts/ OMO purchases. While the Governor implemented these measures (with the exception of CRR cuts) in late January, we had expected additional measures. The Governor has assured these will be carried out when needed. Deferring the LCR norms until March 2026 is good for the short end of the money market curve.

The RBI Governor sounded balanced in his views, and we agree that the neutral stance of monetary policy provides the RBI flexibility to monitor the progress and outlook on disinflation and growth and to act appropriately. We expect yields to trade in a range of 6.65-6.75% in near term. Further liquidity measures rate cuts and OMO's would lead the yields trend lower by 10-15 bps in medium term

We continue to expect a shallow interest rate cut cycle of 50-75 bps. We also expect further proactive liquidity measures by RBI to anchor the overnight rates to the policy rates.

Global economic outlook

After lowering the federal funds rate by 100 bps so far bringing it down to a range of 4.25% to 4.5% ,%, the US Federal Reserve (Fed) maintained a pause in the recent monetary policy citing elevated inflation. The slower pace of disinflation, persistent geo-political tensions and policy uncertainties could hinder rate cuts by most global central banks.

Risks to our view

We see currency, the impact of the US government tariff measures and global inflationary environment thereof as risk to our long duration view. A weakening Rupee can lower the quantum of rate cuts too.

Allocation and strategy is based on the current market conditions and is subject to changes depending on the fund manager’s view of the markets. Data as on 31 January 2025

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DISCLAIMER

Source of Data: RBI Governor’ Statement, RBI Monetary Policy Statement & RBI post policy press conference dated 7^th February 2025, Axis MF Research

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