A calibrated easing cycle: Update on RBI Monetary Policy, February 2025

Rate Action

The Monetary Policy Committee (MPC), under the chairmanship of RBI Governor Shri Sanjay Malhotra, voted to reduce the repo rate by 25bps. The RBI Governor noted the need for a “less restrictive” monetary policy to support growth as inflation remains within RBI’s targeted band (4-6%). All six members voted to maintain the stance at “neutral”. The policy was largely in line with market expectations.

Assessment of Policy Action

1) Rate Cut Rationale: Factors such as moderation in headline CPI in recent months, favorable outlook on food prices and the MPC’s expectations of further moderation in inflation in FY 2026 along with the substantial deceleration in real GDP growth forecast over next few quarters, have created policy space for the MPC to support growth while remaining focused on aligning inflation with the target. 

2) Continuation of Neutral Stance: The MPC decided to continue with a ‘Neutral’ stance to retain flexibility, considering factors like excessive volatility in global financial markets, uncertainties about global trade policies and adverse weather events, which pose risks to the growth and inflation outlook.  

Below are key RBI estimates on the growth/inflation trajectory into the next year compared to their previous forecasts:

Source: RBI, A - Actual

RBI’s comments on the economy and liquidity in today’s policy were:

1) Moderation in Inflation: Headline inflation hit the upper tolerance band in October 2024 and has seen sequential moderation for November and December, 2024. RBI expects significant softening in CPI print going ahead considering factors such as good Kharif production, winter easing in vegetable prices and favourable Rabi crop prospects. Although core inflation is expected to rise, it will remain moderate. RBI noted that uncertainty in global financial markets, volatility in energy prices and adverse weather events present upside risks to its inflation forecast.

 2) Downside Risks to Growth: Growth projections for FY 2025 dropped marginally to 6.4% considering subdued urban demand with high-frequency indicators (tax collection, auto sales, etc.) providing mixed signals. For FY 2026, although the growth projections have been revised downward for the first two quarters, the entire year’s growth projection of 6.7% is higher than FY 2025 projections.

 3) Liquidity: RBI reiterated that it stands committed to providing sufficient liquidity to the banking system and has recently taken several steps in this regard. RBI also mentioned that it will continue to monitor evolving liquidity and financial market conditions and proactively take appropriate measures to ensure orderly liquidity conditions.

 4) External Sector and Currency Management: RBI noted that the Current Account deficit moderated to 1.2% in Q2. India’s forex reserves of US$ 630.6 billion provide sufficient import cover for over 10 months. RBI expects CAD to be well within the sustainable level. RBI also mentioned that its interventions in the forex market focus on smoothening excessive and disruptive volatility rather than targeting any specific exchange rate level or band.   

 Market Reaction:

Today’s rate cut marks the beginning of a shallow rate cut cycle after a gap of almost five years. This cut was widely expected by the market participants and hence bond yields have been dropping over the last few months in anticipation of the rate cut cycle. This has led to significant curve flattening across G-secs and yield curve inversion in the corporate bond space. As the rate cut cycle has started, we now expect the curve to steepen with the short to medium end (up to five years) of the yield curve outperforming the longer end.

Market Outlook

Expect a Shallow Rate Cycle

We expect total rate cuts of 50-75 bps in India during the current rate cycle. We expect a directional bias on the part of market participants to notch down on duration with a shift in focus from the highest duration to intermediate duration to capture accrual along with lower portfolio volatility. This presents an attractive opportunity in the intermediate duration curve (one-five years), especially in liquid corporate bonds in a one- five-year maturity bucket where spreads are in the 60-80 bps range over comparable G-secs. Given that the curve is inverted between short- and long-term corporate bonds, investors can benefit from the curve steepening during the rate cut cycle along with an opportunity to capture on higher accrual in this space.

Given the considerable gap between overnight and money market rates (up to 12 months), investors with a 6– 12-month horizon can consider allocation to low duration/ money market strategies.

Investors with more than 12 months’ investment horizon can consider allocation towards moderate duration (one-to-four year) categories, given the attractive accrual and prospects of mark-to-market gains on these strategies.

The views expressed are author’s own views and not necessarily those of UTI Asset Management Company Limited. The views are not an investment advice and investors should obtain their own independent advice before taking a decision to invest in any asset class or instruments.

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