On February 7, local time, the Reserve Bank of India (RBI) implemented a reduction of the policy repo rate by 25 basis points, bringing it down to 6.25%. This move marks the first decrease in interest rates since May 2020, highlighting a significant shift in the Central Bank's monetary policy approach.

The RBI's Monetary Policy Committee (MPC) characterized its stance as neutral while also emphasizing the importance of keeping inflation in alignment with their long-term target of 4%, which has a permissible fluctuation range of 2% to 6%. In parallel, the committee expressed its intention to foster economic growthThe current Indian inflation level sits comfortably within this target range, and the nation anticipates an economic growth rate of 6.4% for the current fiscal yearThis context created an environment wherein lowering interest rates could effectively stimulate economic activity without compromising inflation stability.

Investors and analysts had largely anticipated this decision

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Prior to the announcement, the RBI had maintained interest rates across eleven consecutive meetings, indicating a cautious approachThe comprehensive decision by all six MPC members to lower the rate was supported by their assessments of economic growth and inflation dynamics, suggesting that while recovery is on the horizon, progress remains sluggish compared to last year.

RBI Governor Sanjay Malhotra underscored the need for a less restrictive monetary policy given the current economic milieu, stating that even as growth projections are optimistic, the deviations from past performance are significantAfter the announcement of the rate cut, there was a slight uptick in the yield of India's benchmark 10-year bonds, rising by 5 basis points to 6.70%. Conversely, the Indian rupee and key stock indices faced minor declines.

This interest rate cut is strategically designed to boost domestic investment and consumer spending, thereby propelling economic growth from the demand side

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Furthermore, as lower interest rates typically result in a depreciating currency, this could enhance the competitiveness of Indian exports, contributing positively to economic growth prospectsIndia currently enjoys substantial foreign exchange reserves, which alleviates concerns over a potential payment crisis as the rupee weakens.

The implications of the RBI's decision extend to the general population as well, where decreases in mortgage and credit card rates are likely, alongside reductions in corporate borrowing costsPrior to this rate cut, the Central Bank had initiated various measures to inject liquidity into the domestic banking system, which included an injection of around $18 billion to tackle the prevailing cash crunchAdditionally, in December, it had lowered the cash reserve ratio by half a percentage point to ease lending conditions.

During the announcement, the RBI hinted at a more accommodating monetary policy stance moving forward, aimed at invigorating a somewhat sluggish economy

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Malhotra noted that the global economic climate remains challenging and growth rates are below historical averagesWhile the Indian economy is by no means immune to global headwinds, it continues to exhibit resilienceCurrent estimates suggest a real GDP growth rate of 6.4% for the fiscal year 2024-25, bolstered by a recovery in private consumptionThe service and agriculture sectors are on a path to recovery, although industrial growth is lagging, presenting a drag on overall economic momentumLooking ahead, GDP growth for 2025-26 is projected at 6.7%, down from a previously forecasted 7.2%.

Earlier, the Indian government had revised its growth expectations, forecasting a 6.4% increase for the current fiscal year, which is below earlier predictions primarily because of sluggish manufacturing and lower corporate investmentsThis fiscal year is poised to become the slowest for Indian economic expansion since the past four years, considering last year's remarkable growth rate of 8.2%.

On the inflation front, the Indian government recently announced tax cuts in its budget proposal to stimulate spending while maintaining tight controls on the fiscal deficit

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Radhika Rao, an economist at DBS Bank, expressed that a tighter fiscal policy would likely coincide with the RBI's supportive stance on growth, especially as the deficit target for 2026 narrows.

Despite inflation rates exceeding the RBI's 4% medium-term target, India's inflation surprisingly moderated to a four-month low of 5.22% in December 2024. Analysts project a gradual decline towards target levels in the next fiscal year, assuming no unforeseen supply shocks disrupt the marketOn February 7, the MPC remarked on the favorable food outlook and the residual effects of past monetary policy actions supporting their inflation expectations, suggesting further easing towards target compliance for the 2025-26 fiscal year.

The RBI's data indicated a decrease in inflation from a recent peak of 6.2% in October to align more closely with their desired levelsThis moderation in overall inflationary pressure was largely driven by decreasing vegetable prices, which had substantially contributed to previous inflation spikes