RBI Policy: MPC cuts repo rate by 25 bps to 5.25%

The Reserve Bank of India (RBI) on Friday cut the repo rate by 25 basis points (bps) to 5.25%, citing a “rare goldilocks period” where growth remains robust and inflation benign, surprising a section of the market that was expecting a pause.

Governor Sanjay Malhotra said that since the October policy, the local economy has witnessed rapid disinflation, and for the first time since the adoption of the inflation targeting framework, average headline inflation for a quarter breached the lower tolerance threshold of 2%. Average inflation measured by the consumer price index (CPI) was at 1.7% in the three months through September, against 0.3% in October.

For the quarter ended September, the Indian economy posted a surprising six-quarter high growth rate of 8.2%, significantly above the RBI’s 7% projection and 7.2% median estimate in a Mint poll of 15 economists.

“…the growth-inflation balance, especially the benign inflation outlook on both headline and core, continues to provide the policy space to support the growth momentum,” said Malhotra.

For FY26, the six-member MPC raised its GDP forecast to 7.3% from 6.8% previously and lowered the retail inflation projection to 2%, from 2.6%.

Malhotra said that growth, while remaining resilient, is expected to soften somewhat. High-frequency indicators, he said, suggest that domestic economic activity is holding up in Q3, although there are some emerging signs of weakness in a few leading indicators. These include PMI Manufacturing moderating to a nine-month low of 56.6 in November; and growth in index of industrial production (IIP) moderating to 0.4% in October from 4.6% in September.

Friday's was the fourth rate cut since February, with pauses in the August and October meetings of the monetary policy committee. So far in 2025, the rate-setting panel has lowered the repo rate by 125 basis points, making loans cheaper and impacting deposit rates.

The yield on the 10-year benchmark government bond closed at 6.50%, down from the previous day's 6.531%. The Nifty 50 rose as much as 0.65% intraday, before closing at 26,186.45, up 0.6% from its previous close.

Malhotra said the more important thing now is to concentrate on the monetary policy transmission. “Considering the fact that inflation is going to be very benign, I think let it first transmit into the real economy and then we will see as to how inflation behaves, how the growth inflation dynamics behave, and we take it policy by policy,” he said, when asked about room for further cuts.

“We believe the RBI over-delivered today, enthusing markets with all they need,” said Aastha Gudwani, India chief economist, Barclays.

She said that if inflation outcomes continue to undershoot current estimates, there is a possibility of further monetary easing in 2026, although the bar for the next cut is quite high.

What also enthused the market was RBI’s liquidity announcements. Malhotra said that the RBI will ensure there is sufficient liquidity. In fact, the central bank announced plans to infuse ₹1.45 trillion into the banking system that has been grappling with sluggish deposit growth and the move is expected to aid transmission of repo rate cuts into cheaper loans. Malhotra said that transmission has been broad-based across sectors. While the RBI lowered the repo rate by 100 basis points since February—excluding Fridays’ 25 bps cut—the weighted average lending rate of banks has declined 69 bps.

This infusion will be through a mix of open market operation (OMO) purchases of ₹1 trillion and ₹45,000 crore ($5 billion) through a three-year US dollar-rupee swap.

Under OMO purchases, the central bank buys government bonds from banks and, in turn, injects money into the banking system. On the other hand, foreign exchange swaps involve the RBI purchasing dollars from banks against rupees held by them, thus infusing liquidity into the system. It then sells back the dollars at a later date, in this case, three years.

Banks and non-banks are expecting improvements in financial conditions on account of the rate cut and RBI’s liquidity measures. “Overall, easier financial conditions will help sustain growth momentum, even as external-sector headwinds persist,” said Rajiv Anand, managing director (MD) and chief executive officer (CEO), IndusInd Bank.

Other bankers said these will aid investments and consumption. “The rate cut will lower borrowing costs and spur both consumption and investment. By acting now, the RBI is bolstering demand without compromising on stability – a balanced move that signals confidence in India’s robust domestic fundamentals,” said K Balasubramanian, CEO of Citi India and banking head for the Indian Subcontinent.

The banking system's liquidity was at a surplus of ₹2.7 trillion on 4 December, compared to ₹2.6 trillion the previous day. Market experts said that the RBI had pointed out in April that liquidity at 1% of net demand and time liabilities (NDTL) or deposits is sufficient for the transmission of past rate cuts. However, over the last few months, banking system liquidity has been below 1% of NDTL.

While the measures will cushion the system at a time advance tax outflows are expected to suck up liquidity, the market clearly wanted more. Madhavi Arora, chief economist at Emkay Global Financial said the primary liquidity infusion of around ₹1.45 trillion is constructive but "modestly below" the expectation of ₹2 trillion for the rest of FY26.

According to Kaushik Das, chief economist, India, Malaysia, and South Asia at Deutsche Bank AG, internal liquidity calculations indicated that there is a need for infusion of durable liquidity to the tune of at least ₹2 trillion by end-March 26. “With the RBI already having delivered ₹1.5 trillion of liquidity infusion in December 2025, we expect a further liquidity infusion in Q1 2026 and in FY27,” said Das.

The rate cut, while cheering borrowers, will compress bank margins. That is because, since 63% of the floating rate loans are linked to external benchmarks like the repo which change almost in tandem with rate cuts, deposits are at fixed rates which do not immediately change. This leads to narrowing of the difference between how much banks earn on loans and how much they pay on deposits. Cutting deposit rate is also tricky since savers have been looking at alternatives to bank deposits and lowering of rates will only push them further away.

While credit grew at 11.3% as on 14 November, deposits grew at a slower pace of 10.2%, showed data from RBI.