After maintaining status quo on policy repo rate at 6.50 per cent since April 2023 — that is, for as many as 10 consecutive bi-monthly cycles — the Monetary Policy Committee (MPC) has turned. The resolution of February 7, 2025, unanimously decided on a policy repo rate cut by 25 basis points (bps) against the background of challenging domestic and global macroeconomic developments.
Data released by the National Statistical Office (NSO) shows that during April 2023 to December 2024, the inflation rate (measured in terms of Consumer Price Index – Combined) was below the 4 per cent mark only on two occasions — July 2024 (3.60 per cent) and August 2024 (3.65 per cent). The inflation rate was above 6 per cent (the upper limit under flexible inflation targeting) on three occasions — July 2023 (7.20 per cent), August 2023 (6.83 per cent) and October 2024 (6.21 per cent).
Quarterly growth rate (measured in terms of GDP at constant prices) as per the NSO data was in the range of 7.8 per cent (Q4 2023-24) and 8.6 per cent (Q3 2023-24). During 2024-25, Q1 growth data was at 6.7 per cent. However, it recorded a significant decline at 5.4 per cent in Q2 2024-25. The MPC for 2024-25 has projected an inflation rate of 4.8 per cent. Thus, the past monetary policy action of keeping the repo rate unchanged has helped moderate the inflation rate, while the growth rate is a matter of concern.
At the current juncture (2025-26), the global economy is growing at 3.3 per cent, which is below the historical average (2000-19) of 3.7 per cent. According to the World Economic Outlook (January 2025 update), the global median of sequential core inflation has been just slightly above 2 per cent for the past few months. The world economic landscape remains challenging with a slower pace of disinflation, lingering geopolitical tensions and policy uncertainties. The strong dollar, among other things, continues to strain emerging market currencies and enhance volatility in financial markets.
Against this global scenario, the MPC has projected economic growth rate at 6.7 per cent and inflation rate at 4.2 per cent, respectively, for 2025-26. Against the above backdrop, here is analysed the: a) liquidity position; b) transmission of the rate cut to bank lending rate; c) credit uptake; and d) policy space for fiscal operations.
Liquidity in deficit
The system liquidity has been in deficit for December 2024 and January 2025, resulting in injection of liquidity by the RBI. The trend has reversed in the first week of February with absorption of liquidity. For example, the net absorption of liquidity as on February 9, 2025, was ₹41,424 crore. Including this absorbed amount, the net outstanding liquidity injected amounted to ₹1,73,927.4 crore as on February 9, 2025. Such higher injection/absorption comes in the way of a true reflection of weighted average call rate (WACR), which is the operating target of the monetary policy.
In view of this, the RBI Governor remarked in his statement: “It has been observed that some banks are reluctant to on-lend in the un-collateratised call money market; instead, they are passively parking funds with the Reserve Bank. We urge the banks to actively trade among themselves in the un-collateratised call money market to make it deeper and vibrant for better signal extraction from the weighted average call money rate (WACR).”
WACR being the operating target must be kept in alignment with the policy repo rate. According to the data released by the RBI in its Weekly Statistical Supplement (WSS), when the policy repo rate was 6.50 per cent, the WACR was 6.57 per cent. Similarly, when the policy repo rate was reduced to 6.25 per cent on February 7, 2025, the WACR was 6.26 per cent. Thus, both the rates are moving in sync with one another.
Furthermore, as mentioned in the October 2024 Monetary Policy report, the transmission of repo rate increased in the easing phase (February 2019 – March 2022), when the reduction of policy repo rate by 250 basis points (bps) resulted in a reduction in lending rates on fresh loans by 232 bps and outstanding loans by 150 bps. Similarly, during the tightening phase (May 2022-February 2023), the increase in the policy repo rate by 250 bps resulted in an increase in lending rates by 190 bps in fresh loans and 119 bps in outstanding loans. Thus, the policy space in connection with the transmission mechanism as mentioned above is incomplete.
The credit uptake, as may be seen from the gross deployment of credit released by the RBI in the January Bulletin 2025, has been encouraging though at a subdued rate. For example, the total non-food credit as on January 17 on the financial year basis was 6.4 per cent and on y-o-y basis was 10.6 per cent. This shows the policy space of rate reduction needs to be translated to the credit uptake.
Fiscal operations
Let us now turn to fiscal operation. The Budget should not have a revenue deficit and the government should not borrow to meet the revenue expenditure as is happening currently. Furthermore, a revenue deficit of 1.5 per cent of GDP as budgeted for 2025-26 reflects the dissaving of the government and has the potential to adversely impact economic growth. Therefore, the priority is to eliminate the deficit.
In this context, it is important to note that the income tax buoyancy of 1.30 for 2025-26 is lower than the average buoyancy of 1.74 recorded in the past five years ending 2023-24. Thus, increasing tax buoyancy is critical and crucial for the elimination of the revenue deficit to ultimately promote growth given the inflexibility of reducing revenue expenditure.
The standard budgetary practice tends to place capital expenditure at a higher level in the Budget estimates and subsequently reducing the same to a lower level to show a lower fiscal deficit-to-GDP ratio. This deviation is against prudent fiscal management and shows poor fiscal marksmanship. Illustratively, we may mention that this has happened during 2024-25 revised estimate where, effective capital expenditure (Expenditure in capital account plus grants-in-aid to State government for creation a capital asset) was reduced from ₹15,01,889 crore to ₹13,18,320 crore, a decline of 12.2 per cent. Therefore, the Budget should keep the effective capital expenditure at ₹15,48,282 crore (as per the Budget estimates), recording an increase of 17.4 per cent in 2025-26. This works out to 4.3 per cent of GDP. This will truly support economic growth.
To conclude, the policy space arising out of the rate cut coupled with credit uptake and prudent fiscal operation would help in evolving a growth-inflation dynamics in line with the objective of monetary policy, which quite simply is “maintaining price stability keeping in mind the objective of growth”.
The writer is a former central banker and Professor at the Gokhale Institute of Politics and Economics, Pune. Views are personal. Through The Billion Press