Context
In its latest policy announcement, the Reserve Bank of India (RBI) reduced the repo rate by 25 basis points to 6.25%, marking its first rate cut in nearly five years. This decision, taken by the Monetary Policy Committee (MPC), aims to counter slowing economic growth by leveraging easing inflation.
· The RBI also revised its growth forecast for FY26 to 6.7%, citing geopolitical tensions, volatile commodity prices, and global financial uncertainties as key challenges.
Implications of the Rate Cut
The reduction in the repo rate is expected to provide relief to borrowers, particularly in interest rate-sensitive sectors such as housing, automobiles, and MSMEs, potentially boosting consumption and investment.
· Additionally, lower borrowing costs could spur economic activity, though the RBI has indicated that future rate cuts will depend on inflation trends and economic conditions.
· While financial markets initially responded positively, there were concerns over a lower growth forecast.
Inflation and Liquidity Outlook
The RBI highlighted a moderation in inflation, with the Consumer Price Index (CPI) easing from 6.25% in October to 5.22% in December. Inflation projections for FY25 and FY26 have been set at 4.8% and 4.2%, respectively.
The central bank also reiterated its commitment to maintaining adequate liquidity in the banking system and urged banks to participate more actively in money markets to facilitate effective monetary transmission.
Understanding the Monetary Policy Committee (MPC)
The Monetary Policy Committee (MPC) is a statutory body established through amendments to the RBI Act in 2016, institutionalizing India's inflation-targeting monetary policy.
Formed under a Memorandum of Understanding (MoU) between the Government of India and the RBI, the MPC plays a crucial role in setting benchmark interest rates to maintain price stability while fostering economic growth.
Structure and Functioning of the MPC
The MPC consists of six members:
- RBI Governor (Chairperson)
- RBI Deputy Governor in charge of monetary policy
- One official nominated by the RBI Board
- Three external members appointed by the Government of India
External members serve a four-year term, and meetings require a quorum of at least four members, including either the RBI Governor or, in their absence, the RBI Deputy Governor. Decisions are made by majority vote, with the RBI Governor holding the tie-breaking vote if required.
Conclusion
The RBI’s decision to cut the repo rate marks a significant shift in monetary policy after nearly five years, aimed at stimulating economic growth amid global uncertainties and domestic challenges such as inflation and liquidity tightening. By maintaining a neutral stance, the central bank has signaled its readiness for further rate adjustments if economic conditions warrant. However, the effectiveness of these measures will depend on how both domestic and global factors evolve in the coming months.
