Effect of RBI Policy on the Indian Stock Market

The much anticipated monetary policy of the RBI has been announced.

India's central bank has cut its repo rate by 0.25%, which now stands at 6.25%.

Why is this significant and how will it impact the economy and the Indian stock market?

We will examine this in this editorial.

Read on...

Significance and Breakdown

This RBI policy was a little different from the usual ones for an important reason. It was the first policy under the new RBI Governor Sanjay Malhotra.

The market had high expectations of a repo rate cut. And they got it.

The repo rate is the rate at which the RBI lends to banks. It was cut from 6.5% to 6.25%.

While this might not seem like a big move, the market certainly thinks it is.

First, the decision was unanimous, i.e., every member of the committee agreed. This sends a clear message to the markets that the RBI is concerned about the slowdown in the economy.

The lower lending rate to banks is a bid to lower interest rates across the economy. This, it is hoped will stimulate economic growth.

Second, the RBI maintained it's neutral stance for the economy. In other words, it has not yet moved to an accommodative policy.

This is because the economic slowdown is not a crisis like situation. Growth will pick up in time. Also, the RBI's battle against inflation has still not been won. As long as inflation isn't tamed, the central bank won't become accommodative.

This is not a concern for the markets. Dalal Street is fine with the RBI's neutral posture. It won't impact market sentiment.

The other important point was the RBI's inflation forecast. The Reserve Bank has projected retail inflation at 4.2% for next financial year. This is lower than the current year's estimate of 4.8%.

This means that inflation will slowly but surely come under control this financial year. Of course, this assumes a normal monsoon. As long as the monsoon is normal this year, the RBI will be confident that inflation will be in check.

Now, this could open the possibility of future rate cuts which will be welcomed by the markets. However, this is not likely to happen soon. The RBI will likely wait and watch to see how inflation and growth plays out over the course of 2025.

Finally, the RBI's GDP growth forecast is also moderate at 6.7% for FY26. This is against the expectation of just 6.4% growth this year.

This means the RBI is expecting an economic recovery but its not expecting a sharp one.

Outlook

The fact that the RBI is not expecting a sharp economic recovery is actually a good thing for the stock market. This is because the market's main concern is higher interest rates caused by higher inflation.

As long as inflation is in check, the risk of rate hikes does not arise.

If the economy were to recover quickly, there could be a rise in inflation due to rising consumption. This became a possibility after the tax cuts in the recent budget.

However, as per the RBI's expectations, the economic recovery won't be sharp. Thus, inflation is not likely to rise sharply either...assuming a normal monsoon.

This is good news for the stock market.

Challenge

The main challenge that we see for the RBI - it's a risk for the stock market too - is the falling rupee, at least in the short term.

The Governor said that while the Indian economy continues to remain strong and resilient, it has not been immune to global headwinds with the rupee coming under pressure in the recent past.

If the rupee continues to fall, India's imports, including crude oil will get more expensive, which in turn, will be a trigger for higher inflation.

The stock market is not very concerned about this right now but it could become a headache for investors if the currency doesn't stabilise soon.

Another challenge is inflation beyond 2025. If the economy recovers fully by the end of the upcoming financial year, then it's reasonable to expect inflation to return sometime in 2026. This demand-led inflation will have to be countered by rate hikes. The market won't respond well to that.

However, for now, the stock market is happy with the RBI.

The next policy meeting to be held in the first week of April will provide more clarity for the markets on interest rates and financial regulation.

We will continue to track these developments for you as and when the RBI makes important decisions.

Happy investing.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...