RBI’s Growth Hopes Mask Limits of Policy Easing

The Reserve Bank of India’s decision to hold the policy repo rate at 5.5% was widely expected. After a front-loading of 100 basis points of rate cuts since February and a surge of liquidity injections, the central bank appears content to let past easing percolate through the economy. Yet the unchanged growth projections accompanying Wednesday’s review reveal more than stability. They underscore the limits of monetary accommodation in addressing deeper structural cracks.

The RBI forecasts average GDP growth of 6.5% in 2025-26, underpinned by a strong monsoon, rising capacity use and supportive policy settings. Inflation, projected at 3.1% for the year, is expected to rise towards 4.4% by March, mirroring the current core inflation trend. This relatively benign outlook leaves space for one more cut later this year, but signals that the easing cycle is near its floor.

Beneath the surface, the sources of optimism warrant scrutiny. Rural demand, which the RBI views as resilient, faces the headwinds of stagnant real household incomes and limited productive job creation. Private investment plans continue to shrink, with official surveys flagging large cutbacks in capital expenditure for 2025-26. Urban consumption, meanwhile, remains sluggish, and the trade outlook has darkened following higher US tariffs and mounting global uncertainties. These crosscurrents limit how much monetary policy alone can do to revive momentum.

Liquidity is abundant, with cumulative infusions of about ₹13 trillion, or nearly 6% of bank deposits, bolstered by impending cuts in the cash reserve ratio. Yet credit growth has slowed to below 10%, less than half its peak in late 2023. Term deposit rates have fallen faster than lending rates.

Due to sustained margin pressure and a lack of credit demand, fresh term deposit rates have declined by 87 basis points to an average of 5.75% since January 2025, outpacing the 71-basis-point decrease in fresh lending rates to 8.62%.

This surplus liquidity situation is likely to extend the competition in bank lending, with lower money market rates, such as Commercial Papers and Corporate Bonds, intensifying margin pressure. Lending preferences are shifting towards collateralised segments, reflecting stress in unsecured credit and early signs of strain in MSME portfolios.

This combination of slowing credit, margin compression and selective lending creates a feedback loop. Monetary transmission is working mechanically through lower funding costs but failing to catalyse fresh demand. With credit demand tepid and corporate investment on hold, the RBI’s surplus liquidity is cushioning banks rather than stimulating the broader economy.

The inflation trajectory adds another layer of complexity. Food deflation has anchored headline CPI, but the relief is concentrated in volatile items such as vegetables. Core inflation has inched up, aided by higher gold prices, and the fading base effect will push headline inflation higher towards the March quarter. The RBI’s cautious stance reflects these risks as well as the uncertain pass-through of higher global tariffs into domestic prices.

Fiscal policy offers limited offset. The government’s commitment to consolidation keeps expenditure tight, leaving monetary easing as the main countercyclical lever. That places greater weight on the efficacy of rate cuts — and raises questions about their diminishing returns in the face of structural drags. Without stronger household income growth or a revival in private investment, further easing may simply deepen liquidity surpluses without spurring credit.

For markets, the takeaway is nuanced. The pause in rate action is no surprise, but the acknowledgement of policy limits tempers expectations of additional support. Surplus liquidity is supportive for valuations, yet banking stocks face a tougher road as credit slows and non-performing asset cycles turn. Historically, such cycles have lingered for years, making selectivity critical: lenders with strong underwriting track records and high provisioning buffers are better placed to weather the next phase.

The broader message is sobering. Monetary policy has done much of the heavy lifting over the past year. Its ability to deliver more is constrained not by inflation alone, but by structural imbalances in demand, investment and employment. Without parallel reforms to boost productivity and incomes, the RBI’s optimism risks sounding hollow. The central bank can buy time with liquidity, but time alone will not close the growth gap.