India Cuts Key Interest Rate for the First Time in 5 Years: GDP Growth Forecasted at 6.7% for 2025

Inflation eases, but markets react with disappointment as RBI adopts a neutral stance on future rate cuts / AFP

In a significant shift for India’s monetary policy, the Reserve Bank of India (RBI) has lowered its key interest rate by 0.25 percentage points, marking the first reduction in five years. This move, announced on February 7, 2025, follows months of economic challenges, including lower-than-expected GDP growth and ongoing inflationary pressures.

The decision to cut the key repo rate to 6.25% was widely anticipated, as India’s economy has shown signs of a slowdown. The country’s economic growth rate for the third quarter of 2024 was just 5.4%, significantly below the RBI’s original forecast of 7%. This marked the lowest growth rate India had seen in two years, signaling a deeper economic slowdown than previously expected.

Despite the challenges, inflation had remained above the RBI’s mid-term target of 4% for much of the past year, preventing the central bank from reducing interest rates earlier. However, after reaching a peak in October 2024, inflation began to ease, falling to 5.48% in November and further to 5.22% in December—well within the RBI’s acceptable upper limit of 6%.

Even with this rate cut, markets showed little enthusiasm. The yield on India’s 10-year government bonds rose by 3 basis points to 6.69%, indicating a drop in bond prices. Meanwhile, the benchmark stock indices, Nifty 50 and Sensex, both saw declines. Analysts pointed out that the RBI’s cautious approach, marked by its neutral stance, may have disappointed investors who were hoping for a more aggressive rate-cut policy in light of India’s rapidly slowing growth.

Bloomberg reported that the market had been expecting the RBI to take a more dovish approach, especially given the swift deceleration in economic growth. Wall Street had initially anticipated further rate cuts as early as April, but the RBI’s conservative stance left investors cautious. Despite these concerns, RBI Governor Shaktikanta Das expressed confidence that India’s GDP growth for the fiscal year 2024-2025 would reach 6.7%, which is slightly higher than the consensus forecast of 6.5% among economists.

The market's reaction to the RBI’s decision was not entirely negative, however. The Indian rupee, which had previously hit an all-time low of 87.5775 rupees per dollar on February 6, strengthened slightly to 87.4037 rupees following the rate cut. This represents a modest recovery after a 2% drop in the rupee’s value against the dollar since the beginning of the year.

Governor Das also addressed concerns over India’s currency market. While the RBI is not actively intervening in the foreign exchange market, he emphasized that any intervention would be aimed at mitigating "excessive and disruptive volatility" rather than targeting specific currency levels. He reiterated that the exchange rate is determined by market forces, and the RBI would continue with its policy of non-intervention unless extreme conditions warrant action.

In conclusion, while India’s central bank has opted for a more cautious approach in its monetary policy, the outlook for the country’s economy remains mixed. The slowing GDP growth, combined with lingering inflation, suggests that India faces a delicate balancing act in the months ahead. Investors and analysts will be watching closely to see if the RBI adjusts its strategy further or maintains its neutral stance.