The Reserve Bank of India has deployed monetary policy as its principal instrument to tackle the dual challenge of containing inflation and supporting growth. While headline inflation has been easing in recent months, the central bank’s immediate priority is to revive economic momentum. Interest rate cuts, a traditional stimulus tool, are at the centre of this effort. But their effectiveness hinges on transmission — how quickly and fully these cuts are passed on by banks to borrowers and depositors.
Between February and June 2025, the RBI cut the policy repo rate by a cumulative 100 basis points. This included a 50-basis-point reduction over February to May, followed by another 50-bp cut in June. The central bank has since moved to a neutral policy stance, giving itself the room to respond to evolving data.
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According to RBI data, as of May 2025, the rate cuts have led to a 24-bp reduction in interest rates on new loans and a 16 bp decline on outstanding loans. However, a closer look at the February–May period shows a more modest outcome: new loans saw a 6 bp decline in lending rates, while existing loans registered a 17 bp fall. On the deposit side, new deposits reflected a 26 bp reduction, but rates on existing deposits remained sticky. The partial pass-through is consistent with patterns seen in previous easing cycles.
Channels of monetary transmission
Economists typically identify three broad channels through which rate cuts influence the broader economy. The first is the interest rate and credit channel. When the cost of funds for banks falls, it allows them to reduce lending rates and expand credit. This, in turn, boosts household consumption and private sector investment, particularly when banks are well-capitalised and willing to lend.
The second is the asset price channel. Lower interest rates often encourage households to take on mortgage loans and firms to invest in fixed capital, thereby stimulating demand in housing and industrial goods.
The third channel operates through the exchange rate. A reduction in interest rates can lead to currency depreciation, which—under conducive external conditions — makes exports more competitive while making imports costlier, thereby helping domestic producers and supporting GDP growth.
In India’s current context, the first two channels are less effective than usual. Household spending remains subdued amid tepid income growth, and private investment continues to be held back by demand uncertainty. The exchange rate channel, meanwhile, is constrained by external risks such as tariff threats, fragile global trade recovery, and ongoing geopolitical tensions that limit export gains from a weaker rupee.
A mixed record on transmission
India’s experience with monetary transmission has been patchy. After the 2008 global financial crisis, despite aggressive rate cuts exceeding 400 basis points, the impact on lending rates was muted due to banking sector stress and tight liquidity. The 2019–20 cycle saw more effective transmission: 250 basis points of rate cuts led to a 150-bp fall in lending rates over 18 months. This was facilitated by structural reforms, particularly the shift to external benchmark-based lending rates, which linked retail credit more directly to the policy rate.
The current easing cycle appears to have benefited from these past changes. The move to external benchmarks lending rate has helped accelerate transmission in parts of the credit market, especially retail loans. Nevertheless, broader transmission remains uneven, hindered by structural issues like operational inefficiencies, banks’ risk aversion, and inconsistent liquidity conditions.
Neutral stance, limited headroom
The RBI’s decision to adopt a neutral stance in June signals a cautious approach in a volatile environment. Governor Sanjay Malhotra has indicated that further monetary easing will depend on incoming data, especially inflation and growth trends. The room to manoeuvre is narrow. Inflation must stay subdued and growth must outperform expectations for the central bank to consider additional cuts.
Banking analysts believe that no major changes in rates are likely in the August policy review unless there is a clear economic trigger. With global uncertainties persisting and domestic consumption yet to pick up pace, the central bank is understandably wary of exhausting its firepower prematurely.
Focus on the transmission mechanism
If the objective is to reignite domestic demand, the challenge is not just about cutting rates but ensuring those cuts translate into cheaper credit across the board. That calls for addressing structural rigidities in transmission. Strengthening the health of public sector banks, reducing non-performing assets, and ensuring adequate systemic liquidity are key enablers.
At the same time, policymakers must acknowledge that monetary policy has its limits. Rate cuts alone cannot generate investment or consumption in the absence of confidence and purchasing power. Fiscal policy, too, must step in—with targeted public spending, tax relief, and infrastructure investments—to amplify the impact of monetary easing.
India’s macroeconomic fundamentals are stronger than many emerging markets, but the runway for rapid, broad-based recovery remains short. With global headwinds intensifying, India must rely more on internal drivers of growth. In that context, the RBI’s effort to improve monetary transmission is timely, but must be matched with wider institutional and fiscal reforms.
The coming quarters will determine whether the current easing cycle delivers a durable boost or merely a temporary reprieve. The answer may well lie not just in the repo rate, but in how effectively the financial system responds.