How the RBI’s silent shift from inflation to growth is reshaping economic priorities

In the first week of June 2025, the six-member Monetary Policy Committee (MPC) of the RBI cut the repo rate for the third consecutive time by 50 basis points to 5.5%. With this, the MPC has retained the GDP growth forecast for the current financial year at 6.5%, stating that ‘geopolitical tensions and weather-related uncertainties may create headwinds’. In addition, the MPC has also opted to cut the cash reserve ratio (CRR) by 100 basis points.

Generally, the consensus among analysts about the impact of this decision on the economy is that it will bring more liquidity into the system, increase demand for investment, housing and consumer durables, and hence boost growth. We understand that all external benchmark lending rates (EBLR) will be reduced accordingly. It has been observed that when RBI reduced the repo rate earlier this year, banks followed suit by reducing EBLR

Markets are generally expecting GDP growth to be higher than the 6.5 per cent projected by the Reserve Bank, but it seems that RBI has chosen to be conservative about its GDP forecast.

For a long time, India’s central bank, RBI (Reserve Bank of India) has been taking a very cautious stance on monetary policy and has been trying to reduce liquidity with the sole aim of controlling consumer inflation based on the Consumer Price Index. This cautious approach of the central bank is neither new nor extraordinary.

We see that globally central banks work with the objective of controlling inflation by reducing money supply and credit supply. However, in India this approach was supported more by the composition of the RBI’s Monetary Policy Committee, which was given the mandate of inflation targeting and tasked with keeping inflation within the range of 4 per cent plus-minus 2 per cent; Which meant that as soon as inflation goes above 4 per cent, the all attention of monetary policy would be on not letting it go beyond 6 per cent. And since then, the RBI's Monetary Policy Committee has been following that mandate almost blindly.

On the other hand, the government's fiscal managers, that is the Finance Ministry and the entire government, feel that the growth rate has to be taken to the highest possible level with the aim of making India a developed economy by 2047, when India will be completing 100 years of its independence. Because of the inflation targeting mandate, the RBI and its Monetary Policy Committee had been treading the cautious path of inflation targeting, not allowing interest rates to go too low, as it felt that this could lead to inflation. For some time now, the growth maximisation objective of the fiscal managers and the government and the inflation control objective of the RBI had been increasingly contradictory to each other.

Where did inflation targeting go wrong?

The inflation targeting framework introduced in 2016, which focused only on Consumer Price Index (CPI) inflation, has actually harmed the country’s macroeconomic interests. CPI is often driven by volatile food and fuel prices, which are primarily supply-side issues, and are not affected by monetary policy tools such as interest rates. As a result, the repeated tightening of monetary policy by the RBI to control inflation has led to higher real interest rates, thereby hampering investment and hurting growth, especially in the MSME sector. We must understand that inflation targeting is an ‘imported’ concept, unsuitable for a developing economy like India, where job creation, rural development and industrial expansion are equally (or even more) important. Therefore, RBI’s lopsided focus on inflation has overlooked the fact that its role is also to promote growth in the country. Moreover, inflation targeting has failed to contain inflation during global shocks such as the rise in oil prices, highlighting the limitations of inflation targeting as a tool of monetary policy.

There was an urgent need to revise the mandate of the RBI to include growth and employment and adopt a monetary policy that reflects India’s specific economic realities.

The political economy of inflation targeting

In recent months, the RBI has undergone two major changes. First, the RBI’s Monetary Policy Committee has been reconstituted, replacing three nominated members whose term had ended and adding new members, Prof Nagesh Kumar, Prof Ram Singh and Dr Saugata Bhattacharya; second, the RBI has got a new governor, Sanjay Malhotra, who replaced Shakti Kant Das, whose term had ended.

Before the reconstitution of the Monetary Policy Committee, a majority of its members were in favour of maintaining the status quo with regard to the policy interest rate, and those who wanted a rate cut were in the minority. But, after the inclusion of three new members, it was clear that interest rates would be cut, and this has now become a reality.

• Big cuts
  
  Though in February and then in April 2015, the RBI, on the recommendation of its monetary policy committee, had cut the repo rate by 25 bps each time, the big cut of 50 bps in June is indeed significant. Though smaller cuts in previous monetary policy reviews were also significant, the objective behind this big cut appears to be to have a bigger impact on credit and liquidity expansion to boost the economy. Big cuts are more important than small cuts in EMIs, seems to be the mantra of this announcement.
  
  What can we expect after the reduction in repo rate and CRR?
  
  I. Firstly, given that lending rates will come down, accordingly, businesses can now borrow at a lower interest rate, home and car buyers can also borrow at lower cost, and will, therefore, pay lower EMIs. We know that Indian businesses are most adversely affected by high cost of borrowing, which makes Indian manufacturing less competitive. Now with the reduction in interest rates, businesses will borrow more aggressively and will be able to expand businesses. This scenario can also help in expanding manufacturing, which is urgently needed in today's times.
  
  II. As we know, bond rates will rise. Interest rates and bond prices are inversely related.
  
  III. While borrowing will become cheaper, a 100 bps cut in CRR will further increase liquidity in the system, which is estimated to be Rs 2.4 to 2.9 lakh crore. Less pressure on deposit mobilization will help banks protect margins, and banks will be able to lend aggressively
  
  IV. Also, government borrowing will become cheaper due to the reduction in interest rates, which will help the exchequer save a huge amount of money on interest.
  
  V. One thing that does not usually attract attention is that lower interest rates in the economy will make corporates more inclined to borrow domestically. Domestic borrowing will become more attractive than foreign borrowing. This will save foreign exchange outgo on interest payments and will also help stabilise the rupee.

Views are personal. The author is Ex-Professor, PGDAV College, University of Delhi