The growth conditions are not very weak, but the downward pressure exerted by monetary, fiscal and credit impulses will lose momentum. The large-scale FX sales made by RBI to limit the depreciation pressure on INR have made last year’s monetary policy more rigorous. This caused a sharp rise in interbank liquidity deficits to INR2TN from surplus conditions in January 2025 to November 2024. At the same time, fiscal policy was inadvertently reduced by a sharp slowdown in capital expenditures by both the government and the state government. Meanwhile, the combination of close liquidity conditions and macroprudential norms has resulted in slowing credit impulses.
Monetary policy is currently changing gears, focusing on growth, and inflationary pressures are behind us. Does the massive liquidity inflation and one rate cut in February raise the question of whether monetary policy stance is really neutral or whether it has become a facility? To answer this, we examine the actual policy rate and its impact on liquidity. Currently, the actual policy rate is 2.5%, based on the Q4FY25 inflation estimate of 3.8%. This is clearly considered to be restrictive, according to estimates of RBI with a neutral real ratio between 1.4% and 1.9%. Based on the Q4FY26 inflation estimate 4.0%, the real rate remains in the 2.3% limit zone. Therefore, RBI should reduce the policy rate by at least 50bps to get the actual policy rate in the neutral zone. Therefore, to ensure that monetary policy remains neutral, it is expected to cut 25bps in April and 25bps in June. Neutral policy stance means that monetary policy will not have a positive or negative impact on growth.
So let’s look at the fluidity of the substantially durable fluidity injection. The system’s liquidity deficit remained rising at INR1.5TN in March 2025. Incorporating government spending and liquidity injection picks that will be made for the rest of March 2025, the system’s liquidity shortage could end in a mild surplus or a mild deficit. This is the same with this adjustment policy. Or you’re just getting a liquidity setting that becomes neutral from the limit. Note, the RBI should inject durable, durable INR2TN with FY26 to ensure that the fluidity of the system is mildly positive. Looking at the growth of the RBI balance sheet, there is a sense of quantitative mitigation. As of March 7, 2025, RBI’s balance sheet growth was tracked at 7%, up from 5.4% as of November 2024. This is still below nominal GDP growth, so the size of the RBI balance sheet is decreasing in GDP percentage. By the end of March 2025, RBI’s balance sheet could be 23% of GDP, slightly below last year’s level (23.6% in 2024). Therefore, despite the incredible quantum of liquidity injection, monetary policy has shifted from contraction to neutral settings in terms of liquidity. Lion share of fluidity injection is already under a neutral stance.
There is another factor that we haven’t discussed. This is the signal utility of policy stance. During Dr. Patra’s tenor, the stance left the liquidity conditions and was linked to future policy rate paths, or signaling. A neutral stance means that rate hiking and cutting are equal. An adjustable posture means that the rate hike is off the table and there is a deeper rate-cut cycle on the card. The posture was changed from neutral to adjustable in June 2019, and the posture was maintained until February 2022. Over this period, the policy rate has decreased by 200bps. Given the expected additional 50bps reductions for the rest of 2025, there is no need to change in stance as it is a shallow speed reduction cycle. Another factor is uncertainty about the Fed policy, taking into account the uncertainty caused by tariffs and fiscal policy changes. The latest Fed dot plot shows that despite slowing growth in the US, the majority of its members will only see a 50bps reduction in 2025. A neutral policy stance makes sense when there is a shallow rate reduction cycle and global uncertainty.
A neutral stance is ideal for monetary policy that navigates a highly unstable global environment. Central banks make decisions around the world and maintain policy flexibility to respond to changing domestic and external impulses. (The author of this article is Gauracentapta, the chief economist at IDFC First Bank.)
