RBI Policy: A Multi-Faceted Growth Boost, but Beware of Asset Inflation
The recent RBI policy has provided a significant stimulus to the economy, but if the real economy cannot absorb the cheap credit, it may lead to asset inflation in equities and real estate.
Rbi PolicyEconomic GrowthAsset InflationLiquidityCreditReal EstateJun 09, 2025
The RBI's decision to front-load the widely anticipated rate cut in August, combined with a generous 50 basis points reduction in the repo rate, has immediate implications for the credit market. Repo-linked loans, including home loans and corporate loans, will see a reduction in interest rates. Non-Banking Financial Companies (NBFCs), real estate firms, and auto companies are likely to benefit from these changes almost immediately.
For banks, the rate cuts may initially impact their margins. However, with inter-bank liquidity at nearly ₹4 trillion, banks are expected to cut deposit rates quickly. The CRR cut, effective from September, will further reduce their cost of funds. This is expected to drive loan growth to the mid-teens by the end of 2025, up from the current 9%. The increased availability of credit is likely to boost urban consumption, which has been sluggish.
The expected credit growth could be a driving factor behind the RBI's decision to retain its GDP forecast for the current year at 6.5%, despite the Street's average forecast of 6.3%. Economists may start revising their GDP forecasts upwards, potentially exceeding the RBI's estimate by the end of the year.
The liquidity injected into the system is substantial. On the day of the policy, the inter-bank market had around ₹3.5 trillion in excess liquidity. Additionally, the government holds about ₹6 trillion in excess cash, partly due to the RBI dividend, which will flow into the inter-bank market as the government spends. Another ₹2.5 trillion will enter the banking system from September to November due to the CRR cut. The CRR reduction has a multiplier effect, potentially increasing liquidity in the system by four to five times over the next two quarters. While about $40 billion or ₹3.4 trillion of short dollar positions will mature this year, absorbing some of the excess liquidity, the system is likely to remain ultra-comfortable. By October, banks are expected to cut deposit rates competitively, leading to lower lending rates.
However, there is a risk that the real economy may not be able to absorb this amount of cheap credit. Global trade remains uncertain, and many CEOs are unsure about production decisions due to tariff uncertainties. In the absence of significant private investment, there is a risk of excess funds chasing retail borrowers, who may use the cheap loans to invest in shares and real estate. This could lead to a stock market boom and a potential asset bubble, which could bring financial excesses.
In the past few decades, such generous liquidity measures have been seen only during crises like the Lehman collapse in 2008 and the post-Covid period in 2021. This is the first time such measures are being implemented in a year of relatively normal growth. While there are external headwinds, it is debatable whether a slowdown caused by tariff uncertainty should be countered with cheap domestic credit.
Despite these risks, the RBI's policy is a significant push towards economic growth. The key will be to ensure that the real economy can absorb the credit and that asset inflation is kept in check.
Frequently Asked Questions
What were the key takeaways from the RBI policy on June 6?
The key takeaways include a 50 basis points repo rate cut, a significant CRR reduction, and the front-loading of the expected rate cut. These measures are designed to boost credit growth and economic activity.
How will the policy impact banks and NBFCs?
The policy will reduce the cost of funds for banks, leading to lower lending rates. NBFCs, real estate firms, and auto companies are expected to benefit from the increased availability of credit.
What is the risk of asset inflation?
If the real economy cannot absorb the cheap credit, there is a risk of asset inflation in equities and real estate. This could lead to financial excesses and potential bubbles.
How much liquidity has the RBI injected into the system?
The RBI has injected a substantial amount of liquidity, with the inter-bank market having around ₹3.5 trillion in excess liquidity and the government holding about ₹6 trillion in excess cash. Additional liquidity will enter the system from September to November due to the CRR cut.
What is the RBI's GDP forecast for the current year?
The RBI has retained its GDP forecast for the current year at 6.5%, despite the Street's average forecast of 6.3%. The expected credit growth could lead to upward revisions of GDP forecasts by the end of the year.
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