RBI’s rate cut is a surprise, given its recent signals, but whether it’ll spur investment is the question

With benign conditions on inflation expected to continue throughout the fiscal year, another rate cut looks likely in February. This is so because inflation will still be low at 0.6% in the third quarter of 2025-26, which will be the reference point for the next policy review.

Also, while GDP growth for the third quarter will not be known, the RBI forecast is 7%, which is lower than the 8.2% achieved in the second quarter. There can hence still be a justification for another cut.

The Monetary Policy Committee (MPC) voted unanimously to cut the rate and maintain RBI’s stance at ‘neutral,’ which is a departure from perception-driven expectations of a change in stance before or at the same time as a rate cut.

In June, when the stance was moved to neutral, the central bank indicated that there were limits to which rate cuts can push up growth. The signal was that there were fewer chances of future rate cuts. Clearly, that view has changed, as a gap between actual and potential growth has been spied ahead that makes a case for monetary policy support. Hence, this rate cut.

RBI’s forecasts of both GDP and inflation have changed sharply, which is understandable given that conditions have been fluid and economic indicators have been affected by extreme base effects.

Inflation has turned out to be much lower than expected, which has led RBI to lower its annual forecast to 2%. Base effects have been very sharp and even though households do feel that prices have gone up, inflation remains benign at less than 1% and this will be so till the end of calendar 2025.

This in turn has fed into the price deflator used for the estimation of GDP growth, a significant part of which is measured in nominal terms and then scaled down to remove price effects. This has pushed up real GDP and brought it closer to the nominal number. Therefore, RBI’s GDP forecast for 2025-26 has increased to 7.3%.

The MPC’s take on liquidity is also interesting. Surplus liquidity today is in the region of ₹2-2.75 trillion. There would be a decline for sure during the period of advance tax payments and continuing towards the end of December, when liquidity usually tightens. The announced open market operations are therefore warranted.

The buy-sell swap of dollars, however, is curious. When $5 billion is purchased by RBI, liquidity is injected into the system. This would be around ₹45,000 crore. However, it would come at a time when the Indian currency is under pressure and there could be an impact here as dollars are taken out of the system.

The market would have been expecting a statement or explanation on recent currency movements, now that the rupee had fallen below the mark of 90 to the dollar. This aspect was not covered, even though other developments on the external front were detailed by RBI.

The central bank offered commentary on the current account deficit and other capital flows, with an assuring conclusion that India has an import cover of around 11 months. Hence, it does look like the central bank would continue to abstain from commenting on the rupee and let the currency find its level.

Overall, RBI is positive on growth and inflation and has assured the system of liquidity, which tends to tighten in December. Bond yields should cool down and the puzzle for banks is to rework their interest rates. Most lending rates linked with external benchmarks would come down and savers can expect lower rates on their deposits. Garnering funds will stiffen as a challenge.

The assumption that industry would borrow more now that rates are lower, thus pushing up investment, will be tested over the months ahead.

These are the author’s personal views.

The author is chief economist, Bank of Baroda, and author of ‘Corporate Quirks: The darker side of the sun’.