Fed turns dial as RBI keeps status quo

US Federal Reserve after a gap of nine months, recently cut the policy rate by 25 basis points as it felt that there is a threat of inflation going up as well the job gains have slowed and unemployment rate has edged up, but remains as Federal Reserve has the twin challenge of balancing of risk of unemployment as well controlling the inflation at a level less than 2%.

Federal Reserve which were holding the rates for a longer time inspite of the greater demand from the President Trump, was going by the data and evolving situation. The imposition of additional tariffs on most of the import items which will have impact on the cost of items for consumption and consequently on inflation and also on economic activities and loss of employment was the areas of concern for Federal Reserve and they were waiting for full impact and get a full picture on these expected fears.

According to FOMC statement dated September 17, 2025, recent indicators suggest that growth of economic activity moderated in the first half of the year. Job gains have slowed, and the unemployment rate has edged up, but remains low. Inflation has moved up and remains somewhat elevated’ Federal Reserve has sees that uncertainty about economic outlook remains elevated and the Committee is seized of the downside risks to both sides of its dual mandate of low unemployment and inflation at the rate of 2 per cent and views that downside risks to employment have risen. With this view, the committee decided to lower the target range for the federal funds rate by 25 basis points to 4 to 4-1/4 percent. This favourable action by the Federal Reserve will have a positive impact on the market.

Another development in US is the temporary government shut down due to budget loggerheads, will likely to raise the expectation of further additional Federal interest rates cuts in October as potential damage from lockdown combined with ongoing concerns over the labour market will outweigh inflation concerns. The impact of Trump's tariffs fully may lead to inflation concerns.

It is to be seen that whether there will be preference of two cuts at the end of financial year 2025 instead of one. There is a feeling that there may be gradual softening that will bring inflation back to Federal Reserve two per cent target in a few years.

BOfA Global Research moves Federal rate cut forecast to October from December as it cites signs of softening labour market. The US government shutdown which began Wednesday has disrupted the release of key economic data that the Federal Reserve relies on to evaluate whether conditions warrant a rate cut.

According to Fed statement, the committee will continue to monitor the implications of incoming information for the economic outlook. The committee assessments will take into account a wide range of information, including readings on labour market conditions, inflation pressures and inflation expectations and financial and international developments. It is likely that there are threats to these factors and there will be further rate cuts expected from Fed and only to watch the extent of cuts likely within the financial year 2025.

Against this developments, we were watching the action of our regulator RBI in their monetary policy meeting held recently on September 29-30 and October 1. The majority of market experts were of the opinion of status quo except few who expected that in view of the recent data of inflation being very low, there may be atleast 25 basis points reduction in Repo rate.

As RBI has done 50 basis points in August policy meeting which was front loaded with rate reduction of that magnitude and there must be full benefit of rate transmission in market rates and particularly lending rates which happens with a lag, as expected RBI has decided to keep the Repo rate unchanged at 5.50 per cent. Consequently the standing deposit facility (SDF) remains at 5.25 per cent and Marginal standing facility (MSF) and the Bank rate remain at 5.75 per cent.

According to RBI, the overall reduction of 100 basis points in the recent period of February - August 2025, the weighted average lending rate (WALR) of SCB moderated by 58 bps for fresh rupees loans, 71 bps is on account of interest rates effect. The moderation for outstanding rupees loans is to the extent of 55 bps. These figures show that full transmission in lending rates fully yet to get effect. While weighted average deposit rates (WADTDR) on fresh deposits declined by 106 bps, while that on outstanding deposits softened by 22 bps over the same period.

It can be observed that while transmission in lending rates gets effected with a lag as well little longer period, whereas on fresh term deposits the effect of cut in fresh term deposits is full and faster., but as you observe on outstanding term deposits is softened only by 22 bps.

This is due to banks when liquidity conditions were tight as well were facing pressure on term deposits growth showing declining trend, were forced to offer higher deposit rates for longer term deposits and as these are not likely to mature immediately, that will have a pressure on margin as deposit cost for some time will remain high, whereas lending rates are sharply coming down.

However, in the background of slow growth in credit, for better rated borrowers banks have to provide competitive rates to ensure adequate credit growth, there may be hesitant to offer full benefit of lower lending rates. These are the interest rates risk banks face both on lending and investment books as well on liabilities side, in the interest rates cycle.

In these circumstances, it is bit difficult for the banks to maintain their profit margin and profitability, but there are other sources of non interest income and substantial fully provided NPA loans recovery which will enhance the prospect of profitability. RBI is of the view going forward, adequate liquidity in the system and the remaining CRR cuts will further facilitate monetary transmission.

Due to favourable factors like favourable monsoon, lower inflation, monetary easing and the salubrious impact of GST reforms, growth Outlook remains resilient even though it remains below their expectations. Because of surprising on the upside GDP growth of 7.8 per cent in Q1, growth for 2025-26 is enhanced from 6.5 per cent in the last policy to 6.8 per cent.

This growth looks reasonable due to US Tariffs and its impact on exports, but due to structural reforms and enhanced consumption and likely project expansion due to higher capacity utilisation, domestic growth drivers will offset to some extent external headwinds.

On the inflation front, due to food prices getting softened which are aided by supply measures taken by the government to effectively manage supply chain, CPI inflation has come down substantially in the recent period. And the headline inflation outlook further looking favourable forward, the inflation projected for 2025-26 has been projected lower than last expectations at 2.6 per cent.

However, CPI inflation outlook for next year Q1 has been projected at 4.5 per cent. Apart from food prices softening, there is a benefit of base effect which is factored in inflation outlook, which will get over later and hence Q1 for 2925-26 is projected at high level.

This is to be noted that against RBI in the earlier policy in August 25, maintained that there may not be much space for immediate further reduction in repo rate as they had effected 50 bps reduction, but due to CPI inflation subsequently has come down and the projected at Q2 at 1.8 per cent, Q3 at 1.7 per cent and Q4 at four per cent and the Committee felt that the current macro economic conditions and the outlook has opened up policy space for further supporting growth.

As the full impact of earlier policy actions are yet to get full impact and the trade related uncertainties are also unfolding, the MPC decided to continue to wait for the impact of policy actions to play out and greater clarity to emerge before next course of action. It therefore likely that there may be future policy actions or Repo rate reduction in the next quarter to further support growth.

In order to boost credit growth, RBI has taken various new reforms opening the opportunity for the Banks to lend for M&A, enhanced credit facilities for lending against shares, removal of restrictions on lending beyond Rs10,000 crore by accessing bond market etc Such reforms are more than 21 in number and we will have to watch how these reforms are having positive impact on Banks growth.

(The author is former Chairman & Managing Director of Indian Overseas Bank)