RBI cuts rates for first time since May 2020

In its first meeting under Governor Sanjay Malhotra, the RBI’s MPC voted unanimously to reduce the policy repo rate from 6.50% to 6.25%. The rate cut was the first by the RBI since May 2020 and reflected shifting priorities within its mandate.

The RBI has a mandate to maintain price stability while keeping in mind the objective of growth. Inflation rose to 6.2% year-on-year in October 2024, driven by higher vegetable prices, but has since moderated to within the RBI’s 4% ±2% target range in November and December (see Chart 1).¹ The MPC believes that the outlook for food prices is favourable and expects headline inflation to remain within its target range until at least Q4 fiscal year (FY) 2025-26.²
 

Chart 1. India consumer price index inflation, RBI inflation forecasts (% change, year-on-year) and policy repo rate (%)

Source: LSEG Data & Analytics and EFGAM calculations. Data as at 11 February 2025.

GDP growth surprised on the downside in Q2 FY 2024-25 at 5.4% year-on-year, below the 6.7% registered in Q2 FY 2024-25 and the RBI’s forecast of 7.0%. The slowdown in growth reflected weakness in the manufacturing sector.³ Although early corporate results for Q3 FY 2024-25 indicate a recovery in the manufacturing sector, and the MPC expects growth to rebound in the remaining two quarters of FY 2024-25, annual GDP growth is still forecast to slow to 6.4% from the 8.2% registered in FY 2023-24.⁴

The MPC outlined that the rationale for its monetary policy decision was the need to support growth, with lower inflation opening up the policy space to do so. While this would suggest that the MPC’s decision represents the start of a significant rate cutting cycle, there are other factors that make us cautious about drawing this conclusion.

The MPC unanimously voted to maintain a neutral stance on monetary policy rather than shifting to an accommodative stance.⁵ Its Monetary Policy Statement noted that “the strong dollar, inter alia, continues to strain emerging market currencies and enhance volatility in financial markets”.

The Indian rupee has depreciated against the US dollar by 1.4% year-to-date, 3.2% since the US election and 4.1% since the start of FY 2024-25. This compares to a decline of 1.4% in the whole of FY 2023-24.⁶

The speed of the decline since the US election can be, at least partially, explained by the strength of the US dollar amid expectations surrounding Trump policies. Nonetheless, the RBI has sought to intervene by utilising its foreign exchange (FX) reserves, which have declined by around USD 41.8 billion since October 2024 (see Chart 2).⁷

Chart 2. USD/INR exchange rate and RBI FX reserves (USD billions)

Source: LSEG Data & Analytics and EFGAM calculations. Data as at 12 February 2025.

The level of FX reserves held by the RBI remains strong, with an import coverage of 9.2 months.⁸ A common rule of thumb suggests a country should hold enough FX reserves to cover at least three months of imports.⁹ Nonetheless, the central bank will be reticent to implement policies that might encourage further depreciation of the rupee. This helps to explain the decision to maintain a neutral policy stance and why we are hesitant about a significant rate cutting cycle in India.

While the direction of Indian rates is likely to be lower, and a rate cut at the next meeting on 09 April is feasible, the stance of monetary policy is likely to remain neutral. It should be highlighted that this outlook reflects not only fundamentals in India’s economy, but also overseas factors. Were the US dollar to depreciate due to a more dovish Fed, for example, then there would be room for more rate cuts in India.

¹ Vegetable inflation was 42.4% year-on-year in October, above the 23.8% year-on-year average exhibited in the previous seven months of the fiscal year.
² https://website.rbi.org.in/web/rbi/-/press-releases/monetary-policy-statement-2024-25-resolution-of-the-monetary-policy-committee-mpc-february-5-to-7-2025
³ Manufacturing sector gross value added rose by 2.2% year-on-year in Q2 FY 2024-25 compared to 7.0% year-on-year in Q1 FY 2024-25.
⁴ Operating profit of 393 listed private manufacturing companies expanded modestly by 0.9% year-on-year during Q3 FY 2024-25, compared to a contraction of 5.4% in Q2 FY 2024-25. https://website.rbi.org.in/web/rbi/-/press-releases/governor-s-statement-february-7-2025#_ftn9
⁵ The RBI communicates a policy stance following each MPC meeting, with possible stances including “accommodative”, “neutral”, and “withdrawal of accommodation”. The neutral stance is generally considered to indicate policy adjustments are possible in either direction, and there is little bias within the MPC.
⁶ EFGAM calculations based on exchange rate data from LSEG Data & Analytics. Data as at 12 February 2025.
⁷ This equates to a 7.0% decline in FX reserves.
⁸ EFGAM calculations based on import and FX reserve data from LSEG Data & Analytics. Data as at 12 February 2025.
⁹ https://www.imf.org/en/News/Articles/2015/09/28/04/53/sopol040711b