RBI's rate cuts, What and Why?

Quick Summary of RBI Monetary Policy Committee announcement

Today, 9th April 2025, the Reserve Bank of India's Monetary Policy Committee (MPC) announced a 25 basis point cut in the policy repo rate, bringing it down to 6% from 6.25% in its previous meeting. This marks the second consecutive rate cut, following a similar reduction in February 2025. The MPC also shifted its monetary policy stance from "neutral" to "accommodative," indicating a readiness to further ease rates if necessary to support economic growth.

What is the importance of MPC?

By adjusting rates like the repo rate, the MPC influences borrowing costs for businesses and consumers. Lower rates encourage spending and investment, while higher rates curb inflation by reducing demand.

The committee also regulates liquidity in the economy, ensuring stability and preventing overheating or stagnation.

The MPC balances its dual mandate of controlling inflation while supporting economic growth, making it central to India's financial health.

What is a Rate Cut and how does it work?

A rate cut is simply a reduction in interest rates by the Reserve Bank of India to stimulate economic growth by making borrowing cheaper and increasing liquidity in financial system.

The RBI lowers the repo rate, which is the interest rate charged by it to other commercial banks borrowing from RBI. This allows banks to borrow money from RBI at a lower cost. This leads to further reduction in interest rates at the consumer level on home loans, car loans and personal loans. This encourages spending activities and investor activities.

But all is not as good as it seems because it ma also lead to lower returns of FD’s(Fixed Deposits) and other savings instruments.

The key implications of a rate cut are that the borrowers may have to pay lower EMI’s. Fixed deposits returns rates might decrease but on a larger scale, borrowing will become cheaper.

Why were the rates reduced?

Prior to February 2025, the Reserve Bank of India (RBI) had maintained the repo rate at 6.5% for nearly 18 months, spanning eleven consecutive MPC meetings. On February 7, 2025, rates were reduced by 25 basis points from 6.5% to 6.25%. (Currently standing at 6%)

The repo rate remained unchanged from August 2023 until February 2025, reflecting a cautious approach to balancing inflation and growth. It was clear that RBI was prioritizing inflation control and hence kept rates constant through the economic uncertainties. The economic growth lost momentum during this period.

Impact of the US tariffs: The imposition of tariffs has created a significant challenge to the Indian economy. The tariffs have created a tremendous inflation pressure on the Indian economy. The costs for certain industries, that rely on imported goods has increased. This has made inflation inevitable and forced RBI to change its stance and introduce rate cuts in February and April 2025, with an expected increase of inflation by 4% with tolerance of 2% more or less. U.S. tariffs have amplified economic vulnerabilities, prompting the RBI to adopt an accommodative monetary policy stance to stimulate domestic demand and offset external shocks.

The GDP growth projection was also brought down from 6.7% to 6.5% for fiscal year 2026, due to global uncertainties and ultimately to stimulate economic growth. By shifting its stance from "neutral" to "accommodative," the RBI signaled its readiness to further reduce rates if necessary to support growth and counter external shocks, like the U.S. tariff imposition, which can lead to higher costs, reduced demand, and slower growth. The RBI's accommodative stance and rate cuts aim to cushion India's economy against global headwinds while supporting domestic growth.

The Market Reaction

Stock Market Reaction:

Equity Markets: Despite the rate cut, the Indian equity markets ended lower. The Sensex fell by 379 points, or 0.51%, to close at 73,847, while the Nifty50 declined by 136 points, or 0.61%, to 22,399.

Banking Stocks: The Nifty Bank Index dropped nearly 1% following the rate cut announcement. Public sector banks like State Bank of India (SBI) and Bank of Baroda saw significant declines, as lower interest rates can compress bank margins.

Reason for Decline: The market's negative reaction was partly due to concerns over the impact of lower interest rates on bank profitability. Lower lending rates can reduce net interest margins (NIMs), affecting banks' earnings.

Other Market Reactions:

Rupee and Bond Yields: The rupee faced depreciation pressures, while bond yields showed a slight decrease following the rate cut announcement.

Global Market Influence: The market sentiment was also influenced by global factors, including U.S. President Donald Trump's announcement of new tariffs on Chinese goods, which heightened global economic uncertainty

What’s Next?

The rate cut by the Reserve Bank of India (RBI) is likely not a one-off event but rather the start of a rate cut cycle. The RBI shifting its stance to accommodative readiness to further ease rates if necessary to support economic growth. This change in stance typically precedes a series of rate cuts rather an adjustment.

The Indian economy is facing challenges such as slowing growth and global trade tensions, which necessitate sustained monetary policy support. Analysts and economists anticipate further rate cuts in the coming months. SBI Research predicts a total reduction of 100 basis points (1%) by March 2026, suggesting that the current cut is part of a broader easing cycle.

Historically, once the RBI initiates a rate-cutting cycle, it continues over several quarters. This pattern is expected to hold true in the current scenario as well, given the ongoing economic challenges.

The Capital Currents’ take:

The RBI’s decision to cut rates by 25 basis points is more than just a reaction to inflation data or global cues — it’s a signal. A signal that the RBI is ready to put growth first, even if it means accepting the inevitable inflation rise.

But here's the nuance: Is the timing right? Currently it looks like inflation is under control — well within the RBI’s comfort zone. But lurking beneath are sticky food prices, volatile oil, and global tensions that could flare up anytime.

With that being said, there’s no denying the current economic reality: private investment is sluggish, and businesses are cautious. A rate cut may ease the flow of credit, banks may start lending more, and encourage consumers to spend. That’s a win for the economy if there was one according to me.

If the market anticipates a rate cut cycle and a rate cut cycle doesn’t happen, the sentiments may backfire and bears might take over. Conversely, too many cuts too quickly could overheat the economy or hurt saving instruments.