Reserve Bank of India has recently announced a 50 bps cut in the repo rate with an aim to stimulate the economy. However, is it a medicine aimed at curing the disease or is it a steroid with no disease in sight? It is more likely a later one, a steroid with no such disease in sight. A slowing economy is not necessarily bad. It is that phase of economy where productive businesses consolidate and unproductive businesses go out of the picture. A growing economy has to go through cyclical phases and its slowing part is quite important for giving economy a strong foundation to reach next level growth. One should remember that Capital is only one factor of GDP growth. Labour and Total Factor productivity are other two important factors required to grow and are of utmost importance in defining the quality of country’s economic growth. Availability of cheap capital in itself cannot fuel growth. However, somehow, In India we have come to believe that cutting rates is a sure-shot way to economic growth but this time around this can back fire especially by threatening the stability of the banking system.

India’s top banks like SBI and HDFC have shown consistent decline in their CASA(Current Account Saving Account) deposits from around 44 percent in FY2023 to Around 38 percent in FY2025.This is primarily the low cost fund mobilization done by banks that vary between 0 bps to 300 bps which is far below than g-sec lending rate that is hovering above 500 bps. This is one segment of deposits which gives banks an edge over NBFCs in raising low cost funds to fuel lending to its customers while maintaining its margins. However, declining deposit rates means investors now don’t want to keep their deposits in this segment. They want to invest into high yield and inflation hedging assets like equity market, real estate. Thus, this repo cut should raise alarm bells for bank as they are going to witness shrinking net interest margin due to increasing borrowing costs and decreasing lending rate.

It is also likely to act as overdose of steroid for economy which may start worsening in different pockets like equity and real estate. The valuation in real estate and equity markets are already stretched and it may further inflate them on the premise that demand should increase. However, should the demand not increase, it can turn into nightmare for the economy. And there are many reasons that this 50 bps cut is unlikely to increase demand in the economy. Unlike Covid, where middle income and high income Indians were flushed with personal savings, the same is not evident now with personal savings too showing a declining trend over last five years. On the other hand , the assets are also not cheap now unlike they were in Covid. All asset classes whether it is gold , equity or real estate look expensive. Further even the demand in retail sector like auto sales is also hovering around its peak. Thus, it doesn’t appear that fresh trigger for demand will be caused by this rate cut.

However, banks and equity markets may have to face the brunt of this rate cut. As discussed, if demand doesn’t pick up and lending growth does not cover up for high borrowing cost in future, the banks are going to be the losers in this rate cut action. The bad news is financial sector companies dominate Indian equity market.37 percent of Nifty 50 is financial sector and if this sector falters, Nifty 50 may have hard time in giving any good returns. However, banks will have major ramifications in case there is further decline in CASA deposits and they are forced to operate as NBFCs. It will make them think whether expanding branch network is really in there interest or they should also start shrinking their branch network especially when borrowing has to be done majorly through debt market. This can be a major blow for the goal of financial inclusion in India as banks will fail to justify creation of new branches if deposits become a fractional source of their funds mobilization.

In conclusion, the repo rate cut of 50 bps is an over dose and is unlikely to work the way it is supposed to work. Investors should keenly watch the Indian bond market which is likely to face exodus of foreign investors due to very narrow spread between US treasury yield and Indian government bonds yield. The other area will be the impact on earnings of banking sector due to this repo cut. If any of these two areas shows weakness, this repo rate could become more of a disease than cure.