RBI MPC Meeting 2025: Markets Seek Complete Monetary Policy Shift, Should RBI Hold Its Ground?

Indian markets are in a state of heightened anticipation ahead of the upcoming RBI policy announcement, with widespread expectations of a rate cut. Some also foresee a reduction in the Cash Reserve Ratio (CRR). Additionally, many market participants hope that the governor, during his press conference, will ensure sufficient liquidity, express satisfaction with the declining credit-deposit ratio, and signal a deferment of new regulations related to Liquidity Coverage Ratio (LCR), Expected Credit Loss (ECL), and project finance.

In essence, the market expects a broadly dovish stance from the RBI to counter economic challenges. However, while a rate cut and liquidity measures are justified, a complete reversal of policy direction may be premature or even risky.

The economic environment has shifted considerably since the last policy meeting in December. At that time, the RBI was contending with a Consumer Price Index (CPI) inflation rate of 6.22%, above the MPC’s mandated 2-6% range. Now, inflation has shown significant moderation, dropping over one percentage point between October and December to 5.2%. 

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Forecasts suggest a further decline to 4.5% in January, with inflation expected to stay within the 4-4.5% range until at least September. By the last quarter of 2025, inflation could potentially fall to 3.5%. Given this outlook, most traders, bankers, and economists predict a reduction in the repo rate from 6.5% to 6.25%, a move the MPC is likely to implement.

Beyond the available policy space for a rate cut, there is also a strong need for one. Economic indicators continue to point toward a subdued recovery. Car sales from leading manufacturers grew by only 1.8% in January 2025. The Services Purchasing Managers' Index (PMI) fell to a two-year low of 56.5 in January, down from 59.3 in December, though the Manufacturing PMI showed a slight improvement at 57.7 compared to 56.4. 

Sales growth for key consumer companies like Asian Paints, Symphony, Dabur, and Greenlam remained in the low single digits for the December quarter. Corporate India has been advocating for lower interest rates and easier liquidity. Additionally, there is pressure to reverse the increase in risk weights on bank loans to Non-Banking Financial Companies (NBFCs), which was raised to 125% in November 2023. With NBFC loan growth now showing signs of slowing, a return to the previous 100% risk weight is being demanded.

One of the key concerns against a rate cut is the sharp depreciation of the rupee against the dollar. As the interest rate differential narrows, holding rupees becomes less attractive, particularly in light of the currency’s recent volatility. While the rupee depreciated by 1.2% over the ten months from January to November 2024, it experienced an equal decline within just five days between February 1 and February 5. 

Some economists argue that capital inflows into India are primarily driven by the country’s long-term growth potential rather than short-term interest rate differentials. They believe a rate cut could enhance India’s investment appeal. While this is often the case, at a time of sharp rupee depreciation, easing monetary policy too aggressively could exacerbate speculative selling pressures.

Amid these concerns, providing an unconditional assurance of ample liquidity could be risky. The ongoing global trade tensions suggest that the rupee’s decline may not be over, making it difficult for the RBI to promise financial stability with certainty. Additionally, inflation risks remain. While projections indicate CPI inflation in the 4-4.5% range for 2025, the MPC must remain cautious. 

The RBI initially forecasted FY25 inflation at 4.3%, only to revise it upward to 4.8% by October. Unanticipated spikes in food inflation remain a possibility. Moreover, this time, rising food prices could translate into higher wages, fueling broader inflationary pressures, particularly as the recent budget has increased disposable income for a significant portion of the population.

Markets will also be looking for clarity on the implementation of new banking regulations. The LCR rules, set to take effect in April 2025, require banks to hold more liquid government bonds due to the rising proportion of short-term deposits. Additionally, draft regulations mandate higher provisions for project finance and infrastructure loans, which have historically been more prone to defaults. The RBI has also proposed shifting to an Expected Credit Loss (ECL) model for loan provisioning, which would require banks to set aside reserves for potential losses in advance rather than after a default occurs. 

The governor is expected to signal that these regulatory changes require further discussion, implying a likely deferment. Such structural reforms should ideally be introduced in stable economic conditions rather than during periods of market turbulence. With the rupee depreciating by 4% in less than four months, the current environment does not indicate stability.

The MPC is widely expected to announce a repo rate cut, with the governor likely to reduce CRR or signal a willingness to implement additional liquidity measures. However, he will also likely reassure markets that LCR and ECL regulations will be postponed. What he must avoid is offering an excessively dovish stance or making sweeping commitments on liquidity. While there are strong reasons to lower interest rates, an aggressive shift in policy—through both increased liquidity and reduced risk weights—could be an overreach at this stage.

Source: Moneycontrol