RBI's monetary policy cycle shows signs of structural shift

The RBI's ongoing monetary policy cycle is diverging from historical patterns in ways that warrant close attention from market participants and policymakers alike. While the central bank has been steering its policy rate, the transmission of these signals through the financial system has become more complex, raising questions about the effectiveness of traditional monetary policy tools.

At the heart of the issue is the relationship between the repo rate—the RBI's primary policy instrument—and the weighted average call rate (WACR), which reflects actual overnight lending costs in the money market. When these two rates operate in alignment, the RBI's policy intentions flow smoothly through the banking system to influence lending rates and economic activity. However, deviations between the two can blunt the impact of policy adjustments.

Experts point to structural changes in India's financial markets as a potential explanation for the current cycle's distinctive characteristics. The growth of alternative funding channels, shifts in liquidity management practices, and changes in the composition of market participants have all contributed to altering how monetary policy transmits through the economy compared to earlier cycles.

Maintaining proper alignment between the repo rate and WACR has become increasingly critical to preserve the credibility of the RBI's monetary policy framework. If the weighted average call rate drifts too far from the official policy rate, it could undermine the central bank's ability to influence borrowing costs and manage inflation expectations, making this cycle a test of the RBI's evolving operational toolkit.