Monetary Policy Watch: Will RBI Infuse Liquidity or Cut Rates?
With the RBI’s policy review around the corner, all eyes are on how the central bank will tackle India’s growing liquidity crunch. Despite calls for rate cuts, the banking system's liquidity shortfall—hitting INR 3.3 trillion—poses a bigger challenge, keeping lending rates high and slowing credit growth. The RBI has rolled out measures like CRR cuts and market interventions, but more action might be needed. With inflation cooling to 4.5% in January, there's room for easing, but the RBI must strike a delicate balance between supporting growth and managing financial stability amid a weakening rupee and global uncertainties
As the Reserve Bank of India (RBI) prepares for its monetary policy review scheduled for February 5-7, addressing the liquidity deficit will take precedence over a simple rate cut to stimulate economic growth. Strengthening credit flow and ensuring financial stability are expected to be the central bank’s primary focus.
The banking system is grappling with a significant liquidity shortfall, which stood at INR 3.3 trillion as of January 25—the highest level recorded since early 2024. Without sufficient liquidity, banks are unlikely to reduce lending rates, potentially slowing down credit expansion and dampening economic activity. In December, the marginal cost of funds-based lending rate (MCLR), a key benchmark for corporate loans, increased by 5 basis points, highlighting persistent funding constraints despite the stable policy rate.
To tackle these challenges, the RBI has already introduced several liquidity-enhancing measures. These include a 50-basis-point cut in the cash reserve ratio (CRR) and the conduct of daily variable rate repo (VRR) auctions. Additionally, open market operations (OMOs) worth INR 101.7 billion were conducted in mid-January to inject liquidity into the system. However, further action may be needed, as projections indicate that the core liquidity deficit could widen to INR 2.5 trillion by March 2025.
On the inflation front, a decline to approximately 4.5% in January—mainly due to a seasonal reduction in food prices—could offer scope for policy easing. Nevertheless, the central bank is expected to tread cautiously to ensure effective rate transmission without exacerbating existing liquidity pressures.
The exchange rate outlook adds another layer of complexity. The rupee has depreciated significantly since September, and ongoing interventions by the RBI to stabilise the currency have exerted further strain on liquidity. The global economic landscape, coupled with potential policy changes in major economies, presents additional uncertainties for India's monetary policy direction.
With these factors in play, the RBI is likely to take a balanced approach, weighing the need for rate cuts against the urgency of liquidity support measures. While a reduction in interest rates may offer relief to borrowers, the broader economic revival hinges on sustained efforts to infuse liquidity and support credit growth.