In a surprise decision, the Reserve Bank of India has reduced policy rates beyond market expectations and moved its political position from the accommodative to the neutral.
The ING group suggests that RBI’s current action indicates a probable break in policy adjustments.
However, the possibility of a future relaxation remains open, subject to potential reductions in growth or inflation.
The Reserve Bank of India (RBI) has considerably reduced the rate of replenishment by 50 basic points (BPS) to 5.5%, exceeding market expectations.
The drop in interest rates brings the total reduction in the REPO rate by the RBI in the current cycle to 100 BPS, which led to a real policy rate of 2.3%.
The RBI has also reduced the cash reserve ratio by 100 BPS to 3%, the lowest since 2021.
“RBI rate actions today make growing convictions within the monetary policy committee that a drop in inflation is likely to persist, and that GDP growth remains on a lower trajectory,” said Deepali Bhargava, regional research manager in Asia-Pacific in AG.
By drops in the front load rate, the RBI seems to guarantee that the advantages of lower rates reach the economy and that there is a lot of liquidity to make things happen.
Not the end of rate reductions
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RBI surprised the markets by modifying its political position of “accommodative” to “neutral”.
This change was particularly unexpected because it only occurred two months after adopting an accommodating position, marking a significant reversal.
“It’s a fairly fast turnover, and it suggests that the central bank could be made with rate drops yet,” said Bhargava.
Even if the inflation of the IPC remains under the objective of RBI and that the real policy rate exceeds the level of comfort typical of about 1.5%, it seems paradoxically somewhat counter-intuitive, according to Bhargava.
She said:
We continue to expect another drop in rates of 25 bp by the RBI this year in the fourth quarter.
The RBI indicates a cessation of policies adjustments but retains the option for additional relaxation if economic growth or the drop in inflation.
It revised the forecast of the inflation of the consumer price index of 4.0% to 3.7% and maintained its GDP growth forecasts at 6.5% for the financial year finishing in March 2026.
“Our own GDP growth estimates are slightly lower than those of RBI, and with real policy rates that are still well above historical standards, we continue to expect a rate drop of 25 pb of RBI later this year, probably in 4q,” said Bhargava.
Impact on the markets
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It is unlikely that a drop in the lonely interest rate considerably affects the Indian rupe (INR), according to ING.
This is probably a reaction to a decrease in inflation rather than an indication of growth concerns.
ING provides for fluctuating market conditions. However, the emphasis on the RBI on the construction of exchange reserves, a slowdown in the growth of the GDP planned due to prices and geopolitical problems, should support the currency and probably cause an upward trajectory.
In the past year, bond return to 10 years has increased by more than 100 basic points.
This increase can be attributed to a combination of factors: reduce inflation rates and a favorable balance between demand and supply.
“We always think that fundamental principles support a new decline in yields, but the pace of decline should be more progressive by here,” said Bhargava.
Given the ample liquidity in the system, the shorter end of the curve should maintain strong support.
