What happened in the latest RBI Monetary Policy Committee (MPC) meeting on 6th Dec 2024.

The News

The RBI announced that it would keep the Repo rate unchanged at 6.5%. This came after India’s GDP growth rate for the Q2 FY25 (July-September quarter) was observed at 5.4%, the lowest in seven quarters, and much lower than the RBI’s forecast of 6.8%.

 Repo Rate

The repo rate is the interest rate at which the RBI lends money to commercial banks. If the repo rate is low, it becomes easy for banks to borrow from the RBI. Banks also give loans at cheaper rates to consumers and businesses. It encourages spending and investment and boosts economic growth.

The RBI has also reduced the GDP growth forecast for FY24-25 from 7.2% to 6.6%, indicating a slowdown. Interestingly, two cabinet ministers—Nirmala Sitharaman and Piyush Goyal, both recently advocated for a rate cut as growth is slowing down. So what’s stopping the RBI from doing the rate cut?

Why is the RBI not doing a rate cut?

Lower interest rates make borrowing easier, increasing overall demand in the economy. As mentioned earlier, this boosts the economy, but it comes with a side effect—inflation. Based on our economic landscape and growth, the RBI has set an inflation target of 4% inflation with a tolerance level of ±2%. So, inflation between 2% and 6% is like a sweet spot to be in.

In October, India’s inflation rose to a 14-month high at 6.21%, higher than a tolerance level set by the RBI. Therefore, cutting rates at this point could lead to persistently higher inflation.

But what about the economic growth slowdown? The RBI itself acknowledged that growth outcomes in India have turned somewhat adverse. Here’s what they have announced.

Unlocking Cash Reserves of Banks

Central banks have multiple tools at their disposal to regulate the money supply in the economy. One of them is the Cash Reserve Ratio.

Cash Reserve Ratio (CRR):
It is the percentage of a bank’s total deposits that it must keep as cash reserves with the RBI. For example, if the CRR is 4% and a bank has ₹100 crore in deposits, it must keep ₹4 crore with the RBI as a reserve.

Banks do not earn interest on the money kept as CRR, so changes in the ratio directly affect their lending capacity.

The RBI has reduced the CRR from 4.5% to 4%. This move will release ₹1.16 lakh crore from bank reserves, allowing banks to offer more loans and increase liquidity in the economy.

To Conclude

The RBI has projected inflation at 5.7% for Q3 (Oct-Dec) and 4.5% for Q4 (Jan-Mar), suggesting a more controlled inflation.

Will things play out as predicted and will it lead to a rate cut in the future? We’ll have to wait and see.