Cumulative rate cuts of ~125-150 bps estimated in FY26 in the best-case scenario with inflation to breach 3% consistently for next 3 months barring any food price shock/heatwave
Dr. Soumya Kanti Ghosh
Group Chief Economic Adviser
State Bank of India
Mumbai, May 5, 2025: The benign inflationary patterns suggest an aggressive rate cut trajectory by India’s Central Bank with key Policy rate likely to breach the Neutral rate by March’26 though the transmission of rate cuts on Deposits may not be even... Cumulative rate cuts of 125-150 bps estimated in FY26 in the best case scenario with inflation to breach 3% consistently for next 3 months barring any food price shock/heatwave .... Jumbo rate cuts of 50 bps could be a better signalling mechanism... Credit-Deposit wedge may aggravate as deposit rates bow down with lacklustre growth while OMOs and a buoyant dividend transfer to ensure no negative surprises on liquidity front and better yield management ...yields to move closer to 6% with a downward bias.
The sharp moderation in CPI inflation, hitting a 67-month low of 3.34% in Mar’25 due to sharp correction in food inflation bodes
well for lowering the average CPI headline forecast for FY26 below 4% now (with below 3% in Q1FY26).... Nominal GDP
growth is expected to be in the range of 9-9.5% for FY26 (Budget: 10%), signifying a Goldilocks period to slash the policy rates
given the low growth and low inflation
❑ With multi-year low inflation in March and benign inflation expectations going forward, we expect rate cuts of 75 basis points
in June and August (H1) and another 50 bps cut in H2 i.e. cumulative cuts of 125 bps going forward while 25 bps rate
cut has already been initiated in Feb’25 (that could put the terminal Rate at ~5.0%-5.25% by March 2026). However, we feel,
jumbo cuts of 50 bps, could be more effective than secular 25 bps tranches spread over the horizon
❑ In response to the 50-bps cut in the policy repo rate since February 2025, banks have reduced their repo-linked EBLRs by a
similar magnitude. While the MCLR, which has a longer reset period and is referenced to the cost of funds, may get adjusted
with some lag. Larger transmission to deposits rates is expected in the coming quarters
❑ Based on the available estimates of natural rate, the neutral nominal policy rates works out at 5.65%.... The current trajectory
of the domestic inflation is well within the band of 2-6% with average inflation based on available data placed at 4.7%. Thus,
there is 70 bps distance before target convergence despite the tolerance.... The potential output growth is estimated at 7%
and based on the advance estimates GDP growth of 6.3% and worst GDP growth at 6%, the output gap is in the range -100 to
-70 bps.... Assuming further convergence of domestic inflation to target, the possibility of cumulative rate cut of 125-150 bps is
also possible by March 2026...implying repo rate declining below neutral rate
❑ Given the dual mandate, the Fed may hold rates in next two cycles.... A pause signal is unequivocal based on recent
statements
❑ We expect the USD/INR pair to stabilize in the range ₹85-87 for 2025.... The domestic impact of tariffs on dollar will be
visible in 2025 which will support rupee...Further, DXY is expected to fall as US domestic economy will adjust to tariff
impact
Accelerated and Unabated series of OMOs showcase RBI’s willingness to go the Extra Mile even as massive OMOs by RBI
fortify the ecosystem though appearing counter intuitive to collective market wisdom at times.... RBI conducts OMO auction for
an overall quantum without security specific limits and retains flexibility to provide allotment to a maximum number of
participants. Typically, amount accepted is always spread among the securities so that any/one aggressive bidder may not
corner the liquidity window
❑ Auctions have also been held in some liquid, on the run papers - probably an attempt to provide liquidity to Banks who do not
run a large, longer duration HTM portfolio
❑ The present move, through OMOs scheduled for another Rs 1.25 lakh cr in May’25, looks aligned to keep liquidity in surplus to
the tune of ~Rs. 2 lakh crore+ as announced by the Governor in the last policy meet, more so factoring in the recent volatility in
the markets and outlook on anchoring durable growth while negating any impact of exogenous shocks’ pass through... Also
the maturing Short Forwards position, initiated to cushion the rupee from undue volatility against a masquerading Greenback
early this year and relentless sell-off by FIIs, now necessitates RBI to put in place countermeasures
❑ OMOs are also expected to build moats around yields.... Yields may remain capped due to replenishment demand from banks
that have offloaded securities in recent OMOs, balancing any spillover from heightened conflict post Pahalgam terror attack
❑ With close to ~Rs. 4 lakh crore of OMO done and another Rs. 1.25 lakh crore (or more!) pending, G-Sec holding by banks as a
% of SLR portfolio is on the decline. Moreover, larger holding by the regulator, at times, tends to affect secondary market
liquidity...RBI dividend could top Rs 2 lakh crores
❑ With rapid transmission of rate cuts desired, deposit rates would come under immediate downward pressure, ensuring
deposits mobilisation remain a Herculean challenge for Banks.... While Credit growth is expected to moderate at 11-12% for
FY26, Deposits may stop shy of double digit growth during the FY accentuating a wedge between Credit-Deposits momentum,
squeezing the NIM of banks adversely
❑ Assuming the % share of ownership is same as that of Sep’24, with slight increase in FPI’s share, the minimum gap to be filled
comes to ~Rs 1.7 lakh Crores in FY26.... OMOs in SDLs may be considered going forward to bring more balance to the
market and align RBI holding to the proportion of outstanding G-Secs and SDLs... Also, the huge number of outstanding SDL
securities (~5000 against ~100-Plus for Central Government) may be rationalized through Buy back
