Why Reserve Bank of India's rate cut alone won’t move India’s growth needle

By Hemantkumar Shah*

The Reserve Bank of India (RBI) has recently lowered its key policy rates, including the repo rate and announced a phased reduction in the Cash Reserve Ratio (CRR), signaling a shift towards a more accommodative monetary stance. At first glance, such a move might appear to herald a phase of economic acceleration—lower interest rates, easier loans, increased investments, and rising employment. However, closer scrutiny reveals that these policy changes, though significant on paper, may not meaningfully impact India’s GDP growth unless accompanied by robust fiscal measures and targeted reforms.

The repo rate, now reduced to 5.5% from a long-held 6.25%, is the interest at which commercial banks borrow from the RBI for short periods. A cut of 0.75 percentage points over a few months is notable. Additionally, the RBI has announced that from September 2025, the CRR will be reduced by 0.25 percentage points, releasing an estimated ₹2.5 lakh crore into the banking system. This liquidity boost should, in theory, enable banks to lend more, which could spur production, jobs, and economic activity.

Yet, the anticipated multiplier effect might not play out as expected. RBI itself projects no substantial change in GDP growth due to these monetary policy adjustments. In fact, while India’s GDP growth for 2024–25 was estimated at 6.5%, the same forecast persists for 2025–26—even after factoring in the policy rate cuts. International institutions mirror this skepticism: the IMF projects a half percentage point decline in growth next year, and the World Bank anticipates a slight dip from 6.5% to 6.3%.

The assumption that rate cuts will energize the economy hinges largely on the responsiveness of two sectors—construction and Micro, Small and Medium Enterprises (MSMEs). Construction accounts for 8–10.5% of GDP, but with 1.1 crore housing units already lying vacant across the country, the scope for new building activity is limited. Meanwhile, there is a recognized shortage of 3.2 crore affordable homes by 2030 and a substantial population still living in slums. Without a strong policy push to bridge this gap, credit availability alone won’t fuel the construction sector’s revival.

As for MSMEs, they are vital engines of employment and exports, contributing 27% to GDP, 50% to exports, and 35% to employment. However, over the past five years, more than 75,000 units have shut down—35,567 of them in 2024–25 alone. This decline underscores structural vulnerabilities. A critical issue is that most MSMEs are micro-enterprises, which often lack access to formal credit. Studies suggest that despite government schemes, these micro units struggle to benefit from interest rate cuts or financial incentives. Thus, even if rates fall, the real beneficiaries may only be larger or medium-sized enterprises.

Another area of concern is the slow transmission of repo rate cuts to end consumers. Despite a cumulative 1% cut since February 2025, many commercial banks have not reduced lending rates for home, personal, or vehicle loans. Without a corresponding drop in retail borrowing costs, demand from consumers may remain tepid. Only if banks align their rates with the RBI’s policy will increased credit actually translate into economic stimulation.

This brings us to a crucial point: monetary policy alone cannot drive broad-based economic growth. Fiscal policy—government spending, subsidies, infrastructure investment, and welfare support—must work in tandem. If growth remains confined to a privileged segment of 40 crore people, and the remaining 100 crore are left untouched, then overall GDP expansion will stagnate. Inclusive development demands greater state action in social infrastructure, housing, rural employment, and health.

In conclusion, while RBI’s rate cuts may provide a psychological boost and marginally increase liquidity, they are unlikely to significantly alter India’s growth trajectory in isolation. Only when accompanied by strategic fiscal interventions that target the underserved majority can the promise of inclusive, sustainable growth be realized. For real transformation, monetary policy must complement, not substitute, bold and equitable fiscal action.

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*Senior economist based in Ahmedabad

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