RBI Reduces Interest Rates By 0.25%

RBI Reduces Interest Rates By 0.25%

Why in News?

Recently the Reserve Bank of India announced to reduce the repo rate by 5.50% to 5.25%.The move came after a three-day Monetary Policy Committee (MPC) meeting, signalling a strategic shift toward cheaper credit as inflation moves to multi-year lows.

Highlights of Monetary Policy Committee (MPC) Meeting 

• The MPC unanimously decided to reduce the policy repo rate by 25 basis points, taking it from 5.50% to 5.25%. The committee maintained its overall monetary policy stance as “Neutral”.
• Following the rate cut, the MPC revised India’s real GDP growth forecast for FY2025‑26 upward to 7.3% from earlier 6.8%. The inflation projection (CPI-based) for FY2025‑26 was revised down to 2.0% from the earlier estimate of 2.6%. 
• To ensure ample liquidity in the banking system, RBI announced additional operations: open market purchases and currency‑swap measures in the near term. 
• India’s recent inflation had dropped to historic lows. This provided the MPC the scope to ease rates without risking inflation overshoot. Meanwhile, the economy remained robust. Real GDP growth in the second quarter (Q2 FY26) stood at 8.2%, marking a six-quarter high. The combination of low inflation and high growth helped frame the decision.
• This year, the Reserve Bank of India reduced the repo rate four times, bringing a total cut of 1.25%. In February, the rate was lowered from 6.5% to 6.25%. Subsequent cuts occurred in April (0.25%) and June (0.50%), and the latest 0.25% reduction.

What is the Repo Rate?

• About: The term Repo Rate refers to the interest rate at which the Reserve Bank of India (RBI) lends short‑term funds to commercial banks. In this process, a commercial bank facing a shortage of cash sells government securities to the RBI. The bank agrees to repurchase those securities later. The cost charged by the RBI for this fund is called the repo rate. This mechanism helps banks meet their short‑term liquidity needs. 

• Authority: The RBI sets the repo rate in India. The decision to raise, lower or maintain the repo rate is made by the Monetary Policy Committee (MPC).

• Objectives: The repo rate serves several key objectives for monetary policy and economic stability, primarily to maintain price stability (control inflation), promote economic growth, and manage liquidity in the financial system. 

• Effects: Changes in repo rate ripple across the economy and affect multiple stakeholders:

• • • Banks: When the repo rate falls, banks borrow more cheaply from the RBI. This lowers their cost of funds, improving their ability to lend. Conversely, when the repo rate rises, banks’ borrowing costs increase and they may cut back on lending.
    • Borrowers: Lower repo rate often leads to reduced interest rates on home loans, car loans, personal loans, and business loans. This reduces EMIs for borrowers and lowers the cost of capital for businesses. Higher repo rate can push up borrowing costs, discouraging new borrowing.
    • Economic Activity: Cheaper credit supports consumption, investment and business expansion. This can spur economic growth. This leads to positive growth in the country’s Gross Domestic Product (GDP). On the other hand, higher repo rate can dampen demand and help cool down inflation. 
    • Liquidity: Repo operations ensure banks have access to short-term funds. This prevents liquidity shortages in the banking system. RBI thereby helps maintain financial stability.

• Inflation: The repo rate directly influences inflation by controlling money flow: raising it makes borrowing costlier, reducing spending and cooling demand and lowering it makes borrowing cheaper, boosting spending, which can push up prices.

• • Exports: A lower repo rate can often lead to a depreciation of the Indian currency (Rupee), making imports more expensive but exports cheaper and more competitive. This benefits exporters and increases the demand for Indian products in the global market.

RBI’s Repo Rate Decision Making Mechanism

• Mandate and Composition: The process is governed by the Monetary Policy Framework. A six-member Monetary Policy Committee (MPC) is responsible for setting the policy repo rate. The committee includes three officials from the RBI and three external experts. The primary objective is to maintain Consumer Price Index (CPI) inflation within a target range, currently 4% with a tolerance band of ±2%.
• Data Analysis: The MPC meets to conduct a detailed assessment of the domestic and global economic environment. They analyze a wide range of economic indicators, including:
  • Inflation Trends: The current and projected Consumer Price Index (CPI) is the top driver.
  • Economic Growth: Gross Domestic Product (GDP) growth rates and forecasts are considered to ensure sustainable expansion.
  • Liquidity Conditions: The amount of money flowing within the banking system is assessed.
  • Global Factors: International interest rates (especially the US Federal Reserve’s moves), crude oil prices, and geopolitical events are factored in.
  • Fiscal Policy: The government’s borrowing and spending policies are also taken into account.
• Deliberation and Voting: During the multi-day meetings, each member presents their analysis and outlook. The final decision on whether to increase, decrease, or maintain the repo rate is made by a majority vote. Each member’s vote and rationale are published in the minutes of the meeting 14 days later.
• Policy Stance and Communication: Along with the rate decision, the RBI announces its monetary policy “stance” (e.g., accommodative, neutral, or tightening), which signals the likely future direction of rates and provides guidance to the market. The decision is made public on the final day of the meeting.