The Reserve Bank of India (RBI) announced a 25 basis points cut in the repo rate during its Monetary Policy Committee (MPC) meeting on February 7, 2025. This is the first such reduction in the past five years, bringing the repo rate down to 6.25%. The repo rate is the interest rate at which commercial banks borrow from the RBI. This decision has been taken to boost the economy and provide relief to borrowers.
But how will this impact the economy, the banking sector, and the Indian stock market? Let’s understand.
What Changes for Borrowers?
A cut in the repo rate directly impacts borrowers’ monthly instalments or EMIs. Those with floating-rate loans may see a reduction in their EMIs. This is because, as of September 2024, 59% of floating-rate loans are linked to external benchmarks (EBLR), which are influenced by the RBI’s repo rate. As banks pass on the benefits of the rate cut to customers, borrowers’ monthly instalments will decrease.
Alternatively, borrowers can choose to keep their EMI amount unchanged and reduce their loan tenure. This can be particularly beneficial for large loans such as home and vehicle loans.
How Will It Boost Credit Growth?
The objective behind cutting the repo rate is to increase liquidity in the economy and encourage credit growth. According to RBI data, non-food credit growth stood at 11.4% in January 2025. Non-food credit refers to total loans issued by banks, excluding those given to the Food Corporation of India (FCI).
However, in recent times, banks have restricted unsecured loans, leading to a slowdown in retail loan growth. In December 2024, the annual growth rate of retail loans (home loans, credit cards, education loans, vehicle loans, etc.) dropped to 12% from 28.4% in December 2023. Similarly, other personal loans grew at just 9.2% in December 2024, compared to 23.2% in the previous year. The repo rate cut is expected to revive growth in these sectors.
When Will Banks Pass on the Benefit?
As per RBI regulations, banks must reset their external benchmark lending rates (EBLR) at least once every three months. This means borrowers can expect the benefits of the repo rate cut within the next three months. However, the speed at which banks pass on this benefit will depend on their internal policies.
Rate Cut: A Challenge or Relief for Banks?
According to Business Today, Elara Securities suggests that the repo rate cut could impact banks’ net interest margin (NIM) in the short term. However, active cash management and the temporary relaxation of certain regulatory guidelines (such as ECL, LCR, and project finance guidelines) will provide some relief to banks.
Large private banks are likely to be the most affected, with their NIMs declining by 15-17 basis points. For mid-cap banks, the impact will be limited to 3-5 basis points, while PSU banks may see a reduction of 10-20 basis points. Meanwhile, some small finance banks could benefit from this cut.
Which Banks Will Benefit the Most from Lower Interest Rates?
Banks that primarily deal in fixed-rate loans will benefit the most when interest rates decline. Lower rates allow these banks to refinance loans at cheaper rates, improving their NIM and profitability. Here’s how different banks are positioned in terms of fixed-rate loans:
Impact on Stock Market and Sectoral Performance
Despite the interest rate cut, the Indian stock market witnessed a decline. On February 7, 2025, the Sensex dropped by 198 points, closing at 77,860, while the Nifty ended at 23,560. The banking sector saw significant losses, with shares of Maharashtra Bank (-2.23%), SBI (-2.11%), and ICICI Bank (-1.21%) declining.
However, the metal and consumer durables sectors witnessed gains, as illustrated in the graph below.
Following the rate cut, stocks in the metal and consumer durables sectors surged. Companies such as Welspun Corp, Tata Steel, and Jindal Steel experienced strong gains. JSW Steel rose by 3.35%, while Dixon Technologies saw a 3.29% increase.
Additionally, consumer durable companies like Vedanta, Blue Star, and Voltas also displayed a positive trend.
Wrapping Up
According to The Economic Times, experts have raised concerns about liquidity conditions. While improvements were observed in February 2025, the banking system could face a liquidity shortfall of up to Rs 2.5 lakh crore by the end of March 2025 if the RBI does not take additional measures.
Such a liquidity crunch could strain the banking system, delaying the full impact of the rate cut on the economy. If the RBI does not inject liquidity in a timely manner, loan availability may be affected, slowing down economic growth.
*The companies mentioned in the article are for information purposes only. This is not an investment advice.
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