Is India’s Current Monetary Policy Easing Cycle Over?

India’s June 2025 monetary policy has three surprises.

First, the Monetary Policy Committee cut the repo rate by 50 basis points compared to market expectations of 25 basis points. Frontloading of the repo rate cut was justified to accelerate monetary transmission to deposit and lending rates.

Second, notwithstanding the large liquidity surplus at the system level—over ₹3 trillion in the RBI’s Standing Deposit Facility—the Cash Reserve Ratio was cut by 100 basis points to 3% of banks’ NDTL, effective from September 6 onwards in four tranches of 25 basis points each.

Third, the MPC unanimously reverted to a neutral monetary policy stance, which was changed in April 2025 from neutral to accommodative. 

While the June policy is aggressively dovish, a hawkish stance does not gel well with the current macroeconomic situation, except for sensitising stakeholders about the limited availability of policy space going forward.  

According to the RBI’s projections, India’s retail inflation is expected to undershoot the 4% target in 2025-26. Moreover, the 6.5% real GDP growth projected for the current financial year is at least 100 basis points lower than the potential. 

This was perhaps the best opportunity for the RBI to pursue an accommodative monetary policy stance. When the inflation and output gaps are expected to remain negative in 2025-26, what is the rationale behind the change in stance? The availability of limited policy space could have been communicated without changing the policy stance. 
 
The neutral monetary policy stance is often interpreted as forward guidance, indicating movement of the repo rate in either direction depending on the evolving macroeconomic situation. 

As credit growth is below 10%, the probability of a repo rate hike in the current financial year is remote. The RBI has not only maintained surplus liquidity but also ensured adequate liquidity, at least up to end-November 2025, by cutting the CRR well in advance. This would also help banks take delivery of forward dollars sold by the RBI without liquidity strains. 

Let us understand the concept of a neutral policy rate. 

If the expected inflation rate is at the target and projected growth is at its potential, then monetary policy is neutral to both inflation and growth. 

The corresponding nominal interest rate is understood as the neutral policy rate, which equals the equilibrium real interest rate plus the inflation rate, a la Irving Fisher’s real interest rate equation of classical tradition. 

The equilibrium real interest rate corresponding to potential output is typically 0-1% in developed countries and 1-3% in emerging economies.  

For debt sustainability, the real interest rate should be significantly below the real growth rate, which varies in the range of 2-3% and 4-6% for developed and developing countries, respectively. 

An RBI study shows that India’s equilibrium real interest rate ranges from 1.4% to 1.9% with the mid-point at 1.65%. As a rule of thumb, India’s equilibrium real interest rate can be approximated at 1.5%. 

Given the inflation target of 4%, the nominal neutral policy rate works out to 5.5%, corresponding to inflation at its target and growth at its potential. The RBI has barely reached the neutral policy rate, which needs further reductions to support growth.

India’s current policy rate is one of the highest among major economies, leading to the real policy rate prevailing above the acceptable level.

Hence, there is scope to reduce the policy rate further to support growth.

As a global growth slowdown is imminent, most central banks would prefer to stay put or move southward in their endeavour to pep up growth.

The policy easing cycle is far from over. Within the limited policy space available, at least another 50-basis-point repo rate cut is needed in 2025–26 to support growth. This will take the easing cycle to bottom out at 5% with a cumulative cut of 150 basis points.

This would also reduce the real policy rate to around 1.5% if the average CPI inflation turns out to be 3.5% in the current financial year.

Hence, out of the remaining four policy announcements in 2025–26, the RBI may pause rate cuts twice, either consecutively or in August 2025 and February 2026.