RBI Initiates Measures to Stimulate Economic Growth: Reflation Underway

RBI Takes Bold Action: Aiming to Stimulate Growth

The Governor of the Reserve Bank of India (RBI) has strategically fired multiple shots with a single metaphorical weapon. By implementing a series of proactive policy easing measures, he aims to counteract further economic slowdown. According to the RBI’s Annual Report for 2024-25, increasing input cost pressures across various sectors pose a significant risk to India’s economic growth.

RBI’s Growth Strategy: The Reflation Begins

During his brief tenure, RBI Governor Sanjay Malhotra has effectively utilized the resources available to him. His decision to front-load rate cuts sends a clear message that the RBI is committed to supporting economic growth, a move that is advantageous not only for the economy but also for the financial markets. It’s worth noting that his predecessor, Shaktikanta Das, faced challenges such as high inflation and a weakening currency, limiting his ability to reduce interest rates despite stagnating growth. Thankfully, inflation levels have been brought under control, allowing the central bank more flexibility in adjusting rates.

The Currency Dynamics

After a period of optimism surrounding Trump’s potential re-election, the robust dollar caused instability in various currencies, driving the rupee to a historic low against the US dollar. Now, the situation has reversed; a weaker dollar has led to a more favorable position for the Indian Rupee. Let us analyze the key factors influencing the RBI’s policy actions and their subsequent impacts.

Liquidity Conditions

The recent cuts to the Cash Reserve Ratio (CRR) and a third consecutive reduction in the repo rate suggest that the central bank aims to ensure sufficient liquidity in the economy. Over the past six months, the RBI has aggressively injected liquidity through secondary market debt purchases, foreign exchange swaps, and open market operations (OMOs). The RBI recently completed its final scheduled bond purchase and hasn’t indicated any new ones yet, complemented now by a CRR reduction. Since February, a cumulative rate cut of 100 basis points has been effectively implemented. The CRR will decrease from 4 percent to 3 percent in four installments of 25 basis points each, starting in September 2025. This move is anticipated to inject ₹2.5 lakh crore into the banking sector in the months ahead.

Impact on Lending Rates

One clear benefit of this liquidity boost is its effect on lending rates. As funding costs for banks decline, the effective transmission of monetary policy to credit markets accelerates. It is crucial that this transmission occurs only when liquidity is plentiful within a falling interest rate cycle. The substantial rate cuts, along with abundant liquidity, are making a real difference in economic transmission, ultimately fostering growth. Of the 50 basis points cut thus far, only 15 basis points has been effectively transmitted; however, we maintain a positive outlook as we expect the pace of transmission to improve alongside increased liquidity.

Financial Market Reactions

Amicable liquidity conditions generally contribute to better financial market performance. Furthermore, the Consumer Price Index (CPI)-based inflation has consistently stayed below the RBI’s medium-term target of 4 percent for three months in a row. Notably, April’s CPI recorded a year-on-year inflation rate of 3.16 percent, as reported by the Ministry of Statistics and Programme Implementation. Consequently, inflation forecasts for FY26 have been revised downwards to 3.7 percent from the previously estimated 4 percent. In the global arena, sluggish growth and flatlining commodity prices will not offer any assistance. Domestically, favorable monsoon conditions and last year’s high comparison base keep food inflation in check. A stable outlook on both inflation and currency is crucial for accelerating monetary reflation, a step the RBI has rightly undertaken.

Growth Challenges

The global economy finds itself at a fragile juncture. Escalating trade tensions, the disintegration of the international trading landscape, policy unpredictability, and the disruption of supply chains have all heightened uncertainty and weighed down growth outlooks in major economies, including the US and Europe. Similarly, the implications of these dynamics raise questions about the future of India’s exports and trade agreements. The RBI’s Annual Report revealed that rising input costs in manufacturing, global trade protectionism, geopolitical conflicts, and subdued demand represent risks to India’s growth trajectory. The growth forecast for FY26 stands at 6.5%. While growth isn’t in a concerning state at this juncture, focusing on bolstering domestic growth amidst global economic anxieties is a commendable approach.

Looking Ahead

The shift in policy stance from the central bank has taken many by surprise. The last policy update indicated an accommodative position, which has now been reverted to neutral. Market perceptions see this movement from accommodative to neutral posture as hawkish, and it may seem slightly premature given the context of ongoing global turbulence and weakening domestic growth. However, we consider this a precautionary measure. The current repo rate is set at 5.50 percent, but future adjustments will depend on how effectively the rate changes transmit through the economy. Although further rate cuts may not be imminent, we believe additional adjustments will be necessary. After a prolonged period of stringent monetary policy, there is an urgent need for reflation now that conditions allow it.

— Ankita Pathak, Macro Strategist and Global Equities Fund Advisor at Ionic Asset