Rate cycle nears end, RBI keeps eye on transmission gaps

The Reserve Bank of India (RBI) maintained a status quo on rates at the February Monetary Policy Committee (MPC) meeting, retaining a neutral stance and a balanced tone. However, RBI Governor Sanjay Malhotra indicated that policymakers are comfortable with the current policy rate and stance for the foreseeable future, signalling an extended pause. The policy outcome belied market expectations of further liquidity infusion.

Experts expect banking system liquidity to improve steadily towards the fiscal year-end. The pressure from persistently high government cash surplus, elevated currency-in-circulation, and FX intervention-related drains is likely to ease in the coming months. With the RBI having delivered cumulative rate cuts of 125 basis points in CY25, the central bank appears to have reached the end of the current easing cycle.

With the RBI having delivered cumulative rate cuts of 125 basis points in CY25, the central bank appears to have reached the end of the current easing cycle.

While transmission through the banking channel has been reasonably strong, it has not been mirrored in bond and money markets. Less than 20 per cent of the cumulative rate cuts have been transmitted to benchmark government bond yields, while corporate bond spreads have widened. Assuming a modest balance-of-payments deficit next year, the RBI may still need to inject Rs4–5 trillion of durable liquidity through open market operations (OMOs) and FX swaps in the next fiscal.

The unanimous pause in the February MPC was driven by an improvement in external pressures since the December meeting, with domestic growth and inflation dynamics remaining comfortable. The MPC upgraded its H1 GDP growth forecast to 7 per cent, reflecting positive momentum. On inflation, Malhotra emphasised that underlying price pressures remain benign once the impact of precious metals is excluded.

Full-year FY27 growth and inflation projections have been deferred to the April policy, as the new data series kicks in from February. While maintaining data-dependent forward guidance, Malhotra stated during the post-MPC press conference that if current macroeconomic conditions persist, the prevailing repo rate of 5.25 per cent could be adequate for the next 9–12 months. This reinforces the view that the RBI has reached the end of the current rate cut cycle, barring fresh shocks.

According to Emkay, this messaging triggered an across-the-board sell-off in the bond market, with 10-year G-sec yields rising 10–12 basis points following the policy announcement and press conference. Although the RBI reiterated its commitment to maintaining adequate liquidity to support productive economic activity and aid transmission, the absence of fresh infusion announcements disappointed some market participants.

Since December, the RBI has conducted OMOs worth Rs 4.2 trillion and USD 25 billion in buy-sell FX swaps. Overall, durable liquidity injection measures since December 2024 total around Rs18 trillion. Looking ahead, assuming a modest BoP deficit, the RBI may still need to infuse about Rs4–5 trillion of durable liquidity through OMOs and FX swaps in the next fiscal.

Despite the deep 125 bps rate cuts over the past year, transmission has been uneven. Lending rates on fresh loans have fallen by 112 bps, while new term deposit rates are down 88 bps. However, less than one-fifth of the cumulative easing has reflected in bond yields during this cycle.