RBI's strategic pause on repo rate amid faltering growth looks ominous

The Reserve Bank of India (RBI)’s decision to maintain the repo rate at 6.5%, marking the eleventh consecutive meeting without a change, comes amid weakening growth. However, the central bank opted to reduce the Cash Reserve Ratio (CRR) by 50 basis points to 4%, a move aimed at infusing liquidity into the banking system.

The second quarter of FY25 recorded a GDP growth of 5.4%, the lowest in seven quarters, primarily owing to weaknesses in the manufacturing sector. Simultaneously, retail inflation rose to 6.21% in October, surpassing the RBI's upper tolerance limit of 6%. This stagflationary environment—characterised by stagnant growth and rising inflation — poses significant policy challenges for the central bank.

The decision to cut the CRR by 50 basis points is expected to release approximately ₹1.2 lakh crore into the banking system, enhancing liquidity at a time when core liquidity is projected to move into deficit owing to unsterilised foreign exchange interventions and cash-in-circulation leakages.

Madhavi Arora, chief economist at Emkay Global Financial Services, emphasises the complexities of the current economic situation by stating: "Policy trade-offs have become even more perplexing with the emerging cracks in the domestic story, with the economy stuck in a stagflationary state."

GDP growth for FY25 was revised down from 7.2% to 6.6%, however, if the growth does not pick up as expected, the governor highlighted that the RBI will step in to provide policy support. Sujan Hajra, chief economist, Anand Rathi Shares and Stock Brokers, too, is flummoxed by the central bank move: “The cut in GDP forecasts for FY25 by 60 bps was confusing given the expectations of material improvement in economic activity in the second half.”

She notes that a CRR cut was the "least costly" measure available to the RBI, considering the challenges associated with conventional rate cuts and the foreign exchange implications. The move to incentivise FCNR borrowings (by raising the interest rate ceiling) reflects the fact that the central bank would be weighing the cost of heavy forex intervention in the past two months ($35-40 billion spot and forwards; $60 billion non-deliverable forwards) amid FPI outflows and limited conviction on steady inflows ahead, mentions Arora.

Anitha Rangan, economist at Equirus, believes that external factors have taken precedence and the RBI will not relent soon on rates until there is some clarity on the extent of the storm in the external world. “RBI revising the interest rate ceiling by 200 bp upwards on FCNR(B) deposits suggests that RBI is worried on the vulnerability on the external front (on USDINR),” mentions Rangan.

The RBI's cautious approach suggests that while immediate rate cuts are off the table, the central bank is prepared to use alternative tools to manage liquidity and support growth. The CRR cut serves as a preparatory step for more effective transmission of potential future rate cuts, indicating a strategic approach to monetary easing amid prevailing economic uncertainties.

However, the decision to maintain the repo rate while reducing the CRR reflects a nuanced strategy to balance the dual challenges of sluggish growth and an uncertain macro.