RBI Cuts Repo Rate Amid Economic Uncertainty

The Reserve Bank of India‘s recent decision to cut the repo rate marks shifts in monetary policy. On April 9, 2025, the Monetary Policy Committee reduced the repo rate by 25 basis points to 6%. This change indicates a shift from a neutral to an accommodative stance, suggesting potential further reductions in the future.

About Repo Rate

The repo rate is the interest rate at which commercial banks borrow money from the Reserve Bank of India. When banks need funds, they borrow at this rate. Conversely, the reverse repo rate is what the RBI pays banks for parking excess funds with it. Currently, the reverse repo rate stands at 3.35%. These rates are crucial as they influence the broader banking interest rates.

Impact on Economic Activity

The repo rate plays a vital role in shaping economic activity. A lower repo rate encourages banks to reduce their lending rates. This makes loans cheaper for consumers and businesses. When borrowing costs decrease, spending and investment typically increase, stimulating economic growth. Conversely, a higher repo rate discourages borrowing and spending, which can help control inflation.

Reasons for the Rate Cut

The RBI’s decision to cut the repo rate comes amid global economic uncertainties. The ongoing trade tensions, particularly those stemming from tariffs imposed by the United States, have raised concerns. RBI Governor Sanjay Malhotra expressed that the central bank is more concerned about sluggish economic growth than inflation at this time. The current inflation rate is averaging 3.9%, below the RBI’s projected rate for the upcoming quarter.

Inflation and Economic Projections

The RBI has projected consumer price-based inflation at 4.8% for the fourth quarter of fiscal 2025. This projection indicates a manageable inflation scenario, allowing room for monetary policy adjustments. The focus on stimulating growth reflects a broader strategy to ensure economic stability in uncertain global conditions.

Monetary Policy Stance

The shift to an accommodative monetary policy stance signals the RBI’s readiness to support economic growth. By lowering the repo rate, the RBI aims to create a conducive environment for investment and consumption. This approach is essential for reviving economic momentum in light of external challenges.

Questions for UPSC:

1. Critically analyse the impact of repo rate changes on consumer spending and business investments in the economy.
2. Explain the significance of the reverse repo rate in the context of monetary policy and banking operations.
3. What are the potential consequences of prolonged low-interest rates on inflation and economic stability? Discuss with examples.
4. Comment on the relationship between global economic conditions and domestic monetary policy decisions in India.

Answer Hints:

1. Critically analyse the impact of repo rate changes on consumer spending and business investments in the economy.

1. A lower repo rate reduces borrowing costs for banks, leading to lower interest rates for consumers and businesses.
2. Cheaper loans encourage consumer spending on big-ticket items and stimulate business investments in expansion and new projects.
3. Increased spending and investment can boost economic growth, creating jobs and enhancing overall economic activity.
4. Conversely, a higher repo rate discourages borrowing, leading to reduced consumer spending and business investments, which can slow economic growth.
5. The effectiveness of repo rate changes may vary based on consumer confidence and overall economic conditions.

2. Explain the significance of the reverse repo rate in the context of monetary policy and banking operations.

1. The reverse repo rate is the interest rate at which the RBI pays banks to park their excess funds with it.
2. This rate helps manage liquidity in the banking system, influencing how banks allocate their funds.
3. A higher reverse repo rate encourages banks to deposit excess funds with the RBI, reducing the money supply in the economy.
4. It serves as a tool for the RBI to control inflation by managing the amount of money circulating in the economy.
5. The reverse repo rate also impacts the overall interest rates in the economy, affecting lending and borrowing behaviors.

3. What are the potential consequences of prolonged low-interest rates on inflation and economic stability? Discuss with examples.

1. Prolonged low-interest rates can lead to excessive borrowing and spending, potentially fueling inflation as demand outstrips supply.
2. Low rates may encourage asset bubbles, where prices of stocks or real estate rise unsustainably, posing risks to financial stability.
3. Examples include the 2008 financial crisis, where low rates contributed to risky lending practices and subsequent market collapse.
4. On the positive side, low rates can stimulate economic growth, particularly during downturns, by encouraging investments and consumer spending.
5. However, if low rates persist, they may lead to a misallocation of resources and a buildup of debt, threatening long-term economic stability.

4. Comment on the relationship between global economic conditions and domestic monetary policy decisions in India.

1. Global economic conditions, such as trade tensions and economic slowdowns, influence India’s monetary policy decisions.
2. The RBI adjusts the repo rate based on external factors, including inflation trends and growth forecasts from major economies.
3. For instance, uncertainty from global trade disputes can prompt the RBI to adopt a more accommodative stance to support domestic growth.
4. Domestic economic health is also affected by global capital flows, exchange rates, and commodity prices, requiring responsive monetary policy.
5. A coordinated approach to monetary policy that considers global trends can help stabilize the Indian economy amid external shocks.