After holding the repo rate at 6.50 per cent for two years, the Reserve Bank of India’s (RBI) six-member Monetary Policy Committee (MPC) has reduced the key policy rate by 25 basis points (bps) to 6.25 per cent. While this marks the first repo rate cut in nearly five years, the RBI decision will lead to a fall in interest rates and equated monthly instalments (EMIs) on home and personal loans.
The RBI’s MPC, in a unanimous decision, lowered the repo rate in a bid to stimulate economic activity by making borrowing cheaper, thereby encouraging spending and investment. This policy shift reflects the central bank’s response to evolving economic conditions and its commitment to fostering growth while managing inflation. The policy panel has estimated the GDP growth at 6.7 per cent and projected the retail inflation at 4.2 per cent for the fiscal 2025-26.
Why did RBI cut Repo rate?
The main reason behind the cut in Repo rate is to stimulate economic growth by making borrowing cheaper for individuals and businesses, leading to increased spending and investment. As inflation is within the RBI’s target range, a rate cut can help maintain price stability while supporting growth.
The rate cut can help banks reduce their lending rates, making credit more accessible and affordable for borrowers. Further, lower interest rates can lead to increased borrowing, spending and investment, ultimately supporting job creation and employment. The reduction will align India with global economic trends, as many central banks have adopted accommodative monetary policies. “The policy panel has noted the decline in inflation,” RBI Governor Sanjay Malhotra said.
What’s the impact?
All external benchmark lending rates (EBLR) — lending rates set by the banks based on external benchmarks such as the repo rate — will come down by 25 bps, giving relief to borrowers as their equated monthly instalments (EMIs) will also fall. Lenders may also reduce interest rates on loans that are linked to the marginal cost of fund-based lending rate (MCLR, or the minimum lending rate below which a bank is not allowed to lend), where the full transmission of a 250-bps hike in the repo rate between May 2022 and February 2023 has not happened.
In response to the 250-bps hike in the policy repo rate since May 2022, banks have revised upwards their repo-linked EBLRs by a similar magnitude. The one-year median MCLR has increased by 175 bps during May 2022 to December 2024.
EMIs on home and vehicle loans will come down, making it easier for individuals to repay their debts. A lower repo rate makes borrowing cheaper for individuals and businesses, which can lead to increased spending and investment, thereby boosting economic growth. With lower interest rates, banks are more likely to lend, making credit more accessible to consumers and businesses.
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However, a lower repo rate can lead to higher inflation, as increased money supply and lower interest rates can drive up prices. It can reduce the interest earned on savings, making it less attractive for individuals to save. It’s worth noting that the RBI’s decision to cut the repo rate depends on various factors, including inflation, economic growth, and global economic trends.
GDP growth & inflation projections
RBI Governor said the RBI will use flexible inflation targeting to make best macro decisions. In the December 2024 monetary policy, the RBI had slashed the GDP growth estimate to 6.6 per cent for FY2025, from an earlier projection of 7.2 per cent. It has now projected a GDP growth of 6.7 per cent in 2025-26.
“The Indian economy has witnessed a slowdown in the current fiscal with consensus estimates of 6.4 per cent GDP growth from 8.2 per cent in FY24. While headline inflation has moderated to 5.2 per cent in Dec’2024 and is expected to subside further to 4.5 per cent over the next few months, there are concerns on its sustainability amidst the rupee touching 87 to the US dollar,” said Suman Chowdhury, ED & Chief Economist, Acuité Ratings.
India’s GDP growth estimate for the financial year 2024-25 is 6.4 per cent, according to the First Advance Estimates released by the Ministry of Statistics and Programme Implementation. This estimate is slightly lower than the Economic Survey’s projection of 6.5 per cent to 7 per cent growth.
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Retail inflation is expected to be 4.2 per cent in 2025-26, Governor said. “We expect a significant moderation in headline retail inflation in January 2025. Retail inflation is expected in the range of 4.5-4.7 per cent. The inflation outlook is evolving broadly in line with estimates, with significant support stemming from easing prices of vegetables,” Bank of Baroda said in a report. Global prices of edible oils too have softened, which is positive for domestic inflation trajectory
