Economists at SBI are expecting a rate cut of 25 basis points in the monetary policy committee meeting on February 7^th, 2025. The report further added that going forward there was a cumulative rate cut of 75 basis points with two successive across February and April in 2025.

The current pauses by the Federal Reserves along with the fiscal stimulus from the RBI budget at least in the short run have the room for rate cuts to tackle inflationary pressures.

The global economy is weathering the aggressive restraint of monetary policy. Global growth is expected to stabilize at 3.2%- 3.3% without accounting for the Global Trade wars. Factoring the impact of trade wars, global GDP may see a downside of 30-35 bps in 2025.

Global inflation is continuously softening due to the declines in food inflation, but remains uncertain, accounting for the trade wars. Domestic CPI inflation is expected to moderate to 4.5% in Q4 FY25 and average to 4.8% in FY25. January inflation numbers are tending closer to 4.5%...FY26 will average between 4.2%-4.5%. October- December 2026 inflation could be lower than 4%.

In 2024 there were total rate cuts of 195, in comparison to the global rate hikes at 31. With China’s growing trade protectionism and slowed domestic growth there might be an acceleration in policy accommodation. The dollar is expected to be appreciated and will create significant pressure on the exporting countries.  

As per the Budget Documents, total borrowings including budgetary estimates for the FY25 of government stood at Rs 19.9 lakh crore, 6.1% of the GDP and the same for FY26 at Budget Estimates is Rs 23.1 lakh crore, 6.5% of the GDP. This amount is relatively comfortable for fiscal policy to support monetary policy.

In the Union Budget 2025-26, the Government has computed several fiscal scenarios based on the GDP growth trends and varying degrees of fiscal calibration in the next 5 years. Considering all the scenarios from most pessimistic to average and most optimistic, Gross Market Borrowing would be in the range of Rs 93.8-95.2 lakh crore with an average of Rs 18-19 lakh crore per annum. It is thus imperative for the government to look at other sources of borrowing like small market savings. According to the report of SBI, this borrowing would be financed 75% through long-term instruments and 25% through securities issued against small savings.

As per the RBI report, “the debt path over the next five years, even under the best-case scenario, will further squeeze fiscal space unless strategic policy efforts covering both taxes and expenditure aim at targeted consolidation, without relying perpetually on the wobbly comfort from a favourable interest rate minus growth condition of debt sustainability.”

Additionally, the report tried to understand the Rupee-Dollar Exchange Rate using Variance Decomposition, using quarterly data from FY18 to FY24. It was segregated into self, growth and non-growth sectors. It concluded that the growth factors (growth rate of Real GDP, Leading indicators etc.) dominantly explain the rupee volatility in the long run (72%) whereas non-growth factors (Dollar Index, Call Money market rate etc.) explain the volatility in the short term (45%).

This substantiates that using interest rates as an alibi for protecting the exchange rate in an inflation-targeting regime is inconsistent with the mandate. With unchanged ownership in Government securities in FY26, the OMO (Open Market Operations) gap in FY26 could still be around Rs 1.7 trillion. Thus, more liquidity measures could be required on a sustained basis. The RBI could investigate using the Cash Reserve Ratio more as a regulatory intervention tool / countercyclical liquidity buffer rather than as a liquidity tool in future. There is an urgent need to revisit the existing liquidity management framework of RBI by replacing the WACR as a policy rate as it does not serve the intended purpose.