The Reserve Bank of India’s (RBI) six-member Monetary Policy Committee (MPC) Friday cut the repo rate — the rate at which the RBI lends to other banks by 25 basis points to 6.25 per cent.

The decisions of MPC of the Reserve Bank of India play a pivotal role in shaping the country’s economic landscape. By adjusting key policy rates and employing various monetary tools, the MPC influences inflation, economic growth, and financial stability.

This article delves into the MPC’s impact on India’s domestic economy, provides a sectoral analysis, discusses limitations—particularly concerning the informal banking sector—and examines how fintech and digital lending are mitigating informal borrowing, supported by Indian case studies.

The Role of the MPC in India’s Economy

Established in 2016, the MPC is tasked with setting the policy repo rate to achieve the inflation target while considering economic growth. The committee comprises six members: three from the RBI and three external experts appointed by the government. The primary objective is to maintain price stability, with a medium-term target of 4% Consumer Price Index (CPI) inflation within a tolerance band of ±2%.

The MPC’s decisions directly influence the cost of borrowing, consumer spending, and investment activities. For instance, a reduction in the repo rate can lower borrowing costs for businesses and consumers, potentially stimulating investment and consumption. Conversely, an increase in the rate can help curb excessive inflation by making loans more expensive, thereby reducing spending.

Sectoral Impact of MPC Decisions

The MPC’s policy decisions have varied effects across different sectors of the Indian economy:

1. Banking and Financial Services: Changes in the repo rate directly influence banks’ lending and deposit rates. A lower repo rate encourages borrowing by reducing loan costs, while a higher rate curtails excess liquidity to control inflation. However, the transmission of rate cuts to end consumers depends on factors like banks’ liquidity positions, deposit rates, and overall financial health. As of December 2024, the RBI reduced the Cash Reserve Ratio (CRR) to 4% from 4.5%, injecting approximately ₹1.16 lakh crore into the banking system to enhance liquidity (India Budget). This move aimed to improve credit availability and lower borrowing costs, though its effectiveness depends on banks passing the benefit to consumers.

2. Real Estate and Housing: Lower interest rates make home loans more affordable, boosting housing and real estate demand. This can drive construction activity, benefiting cement, steel, and allied industries, thereby creating employment opportunities. Following a 25-basis point repo rate cut in February 2025, industry experts projected a rise in residential demand, particularly for properties priced under ₹5 million. Lower home loan rates and government tax incentives were expected to revive the affordable housing segment.

3. Automobile Industry: Interest rate reductions make auto loans cheaper, encouraging vehicle purchases in both the passenger and commercial vehicle segments. This supports domestic automobile manufacturers and boosts consumer spending. After the February 2025 rate cut, auto stocks surged by 1%, reflecting positive market sentiment due to expectations of increased vehicle loans and sales. However, long-term demand also depends on fuel prices, production costs, and consumer confidence.

4. Micro, Small, and Medium Enterprises (MSMEs): MSMEs rely on bank credit for working capital and expansion. Lower policy rates can reduce borrowing costs, facilitating business growth. However, credit transmission challenges may prevent MSMEs from fully benefiting from rate cuts. Despite policy rate cuts, credit growth to MSMEs moderated to 7.5% up to December 27, 2024, compared to 11% in the same period the previous year, indicating structural challenges in credit uptake (India Budget). Many MSMEs still face collateral constraints and documentation hurdles in accessing formal credit.

5. Agriculture: The Agricultural loans become cheaper with lower interest rates, allowing farmers to invest in better seeds, fertilizers, and equipment, potentially boosting productivity. However, factors like minimum support prices (MSP), monsoon performance, and input costs play a larger role in agricultural growth. While the RBI’s policies aim to ensure adequate credit flow to agriculture, specific data on the impact of recent rate cuts remains limited. Government schemes such as Kisan Credit Cards (KCCs) and interest subvention programs complement monetary policy in ensuring accessible farm credit.

6. Consumer Goods: Lower borrowing costs increase disposable income, driving spending on durable goods like electronics, appliances, and automobiles. This benefits manufacturers, retailers, and the broader supply chain. Following the February 2025 rate cut, sectors like real estate and automobiles—both highly sensitive to interest rates—saw stock market gains, signalling improved consumer sentiment. The rise in discretionary spending was expected to positively impact the retail and FMCG sectors.

Positive Impacts on the Domestic Economy

1. Lower Borrowing Costs: A cut in the MoC will reduce lending rates, making it cheaper for businesses and individuals to borrow, which can boost investments and consumption.
2. Increased Business Investments: Lower interest rates encourage companies to take loans for expansion, increasing production and employment.
3. Boost to Consumer Demand: Cheaper loans can stimulate demand for housing, automobiles, and consumer durables, thereby strengthening economic activity.
4. Support for Government’s Growth Push: If the government is focusing on infrastructure spending, lower interest rates can support financing for large projects.
5. Stock Market Gains: Equity markets often react positively to lower interest rates as they make borrowing for companies cheaper and improve corporate earnings.

Potential Challenges

1. Transmission of Rate Cuts: Banks may not pass on the full benefit of lower MoC to borrowers, limiting its impact.
2. Inflationary Pressures: If demand rises too quickly, inflation can go up, prompting RBI to reverse the rate cut.
3. Weakening of the Rupee: Lower rates may lead to capital outflows as investors seek higher returns elsewhere, weakening the rupee.
4. Limited Impact if Credit Demand is Low: If businesses are uncertain about future demand, they may not borrow despite lower rates.

Banks may not fully pass on the Marginal Cost of Funds-based Lending Rate (MoC) cut to borrowers due to several reasons:

1. High Cost of Deposits: Banks rely on deposits for funds, and if deposit rates remain high, they cannot significantly lower lending rates without reducing their profit margins.Public sector banks, in particular, have a large base of fixed deposits with pre-committed interest rates, making it difficult to reduce lending rates immediately.

2. Weak Credit Demand & Risk Aversion: If economic conditions are uncertain, banks may be hesitant to lend aggressively, fearing a rise in non-performing assets (NPAs).They may retain higher lending rates to compensate for potential bad loans, rather than pass on the full MoC benefit.

3. Slow Monetary Policy Transmission: Even if RBI cuts MoC, banks adjust their rates gradually due to liquidity conditions, regulatory norms, and internal risk assessments.Past trends show that the transmission of rate cuts to actual lending rates takes time, sometimes several months.

4. Capital Adequacy & Profitability Concerns: Banks need to maintain a certain Capital Adequacy Ratio (CAR) as per Basel norms.If their profitability is under pressure due to low net interest margins (NIMs), they may delay rate cuts to protect their financial health.

5. Competition & Market Structure: Large banks with strong pricing power may not cut rates aggressively, especially if competition from smaller banks or NBFCs is low. If deposit rates remain high, banks may fear losing customers to small finance banks or post office schemes offering better returns.

6. RBI’s Liquidity Management Actions: If RBI tightens liquidity (through open market operations or cash reserve ratio hikes), banks may hold back on passing rate cuts to preserve their funds.

Impact of MPC on the Informal Banking Sector

The informal banking sector in India, which includes moneylenders, chit funds, self-help groups (SHGs), and unregulated non-banking financial entities, remains a significant credit provider for many rural and semi-urban borrowers.

67% of rural households still depend on informal credit sources for small-ticket loans (NSSO, 2019). Informal sector lending interest rates remain in the range of 24%-120% annually, compared to 8-12% in banks. Only 11% of MSMEs had access to formal credit as of 2022, highlighting the financing gap that informal banking fills (TransUnion CIBIL Report, 2023).

Despite RBI’s monetary policy interventions, this sector often remains untouched by changes in repo rates and formal banking regulations. Here’s why:

1. Independence from RBI-Regulated Interest Rates: Informal lenders do not borrow from RBI-regulated institutions and instead rely on personal capital or local financial networks. Since their cost of funds does not change with repo rate movements, RBI’s rate cuts have no direct impact on their lending rates.

2. High Demand for Informal Credit Despite Lower Bank Lending Rates: Many borrowers, particularly in rural and semi-urban areas, lack access to formal banking channels due to limited documentation, low financial literacy, and geographical constraints. Even when formal interest rates decrease, the procedural complexities and collateral requirements in banks drive people to informal lenders despite their higher interest rates.

3. Usurious Lending Practices: Moneylenders and unregulated lenders continue to charge exorbitant interest rates (often between 3% and 10% per month), irrespective of MPC decisions. According to a SIDBI study (2019), more than 30% of small businesses still rely on informal lenders, despite growing access to formal credit.

4. The Role of Shadow Banking in India: NBFCs and microfinance institutions (MFIs) operate at the edge of formal and informal finance. While they are partially regulated, their cost of funds is often higher than commercial banks. This means that even if the MPC reduces policy rates, NBFCs and MFIs may not lower their lending rates significantly, keeping informal borrowing costs high.

5. Cash-Based Transactions Limit Monetary Policy Effectiveness: A significant portion of informal lending is cash-driven, outside formal banking records, making it immune to RBI’s policy changes. Borrowers in this sector prefer flexibility over lower rates, as informal lenders offer quick credit without documentation—an area where banks still struggle.

6. Government Efforts to Bridge the Gap: Initiatives like Jan Dhan Yojana, MUDRA loans, and digital banking expansion aim to reduce reliance on informal credit sources. However, implementation challenges, bank NPAs, and lack of financial literacy continue to keep informal lending alive.

While the MPC can influence formal credit markets, its impact on informal banking remains minimal due to structural gaps in financial inclusion. However, fintech and digital lending platforms are emerging as potential disruptors to the informal lending ecosystem. Let’s explore how.

Fintech and Digital Lending Are Reducing Informal Borrowing

The rise of fintech and digital lending platforms in India is transforming credit accessibility, particularly for those previously reliant on informal lenders. These innovations are gradually bridging the financial inclusion gap by offering faster, collateral-free, and data-driven loans.

1. Alternative Credit Scoring- A Game Changer: Traditional banks rely on CIBIL scores and credit history, excluding millions without prior formal borrowing experience. Fintech lenders use AI, transaction data, GST returns, and mobile phone usage patterns to assess creditworthiness. Example: Lendingkart, a fintech NBFC, evaluates over 5,000 data points and provides MSME loans without collateral within 72 hours.

2. Paperless, Instant Loans via Digital Platforms: Unlike traditional banks that require physical documents and long approval times, fintech lenders offer fully digital, instant loans. Example: RBI’s Digital Lending Guidelines (2022) facilitated the rise of platforms like KreditBee and LazyPay, offering instant consumer loans under ₹50,000.

3. Expansion of Microfinance & NBFC Lending: NBFCs and Microfinance Institutions (MFIs) are leveraging fintech to expand credit access to rural borrowers. Example: BharatPe’s Merchant Cash Advance model provides loans to small shopkeepers using their UPI transaction history as a credibility metric. As of March 2023, MFIs disbursed ₹3.85 lakh crore in loans, a 16% YoY growth, indicating their increasing reach.

4. Buy Now, Pay Later (BNPL): A Formal Credit Alternative: BNPL services act as short-term, interest-free loans, encouraging first-time borrowers to enter the formal credit system. Example: ZestMoney and Simpl have enabled millions to access credit without credit cards. The BNPL market in India is projected to reach $45-50 billion by 2026 (Redseer Consulting).

5. Government-Backed Digital Credit Initiatives: UPI-based credit access is gaining traction, directly transferring small loans via Aadhaar-linked accounts. Example: MUDRA loans (₹4.5 lakh crore disbursed in FY 2023) have increasingly adopted digital processing.

Indian Case Studies: Fintech Impact in Action

Paytm’s Digital Lending for Small Businesses: Paytm introduced merchant loans using AI-driven risk assessment. ₹9,618 crore loans disbursed in Q2 FY24, growing 122% YoY. Helped small traders access working capital without informal borrowing.

Mahila Money – Empowering Women Entrepreneurs: A fintech platform offering small business loans exclusively for women. Over 3 lakh women entrepreneurs financed, reducing reliance on high-cost informal loans.

KreditBee’s Instant Personal Loans for Gig Workers: Provided loans of ₹10,000 to ₹2 lakh to self-employed individuals without formal income proof. Helped gig economy workers avoid moneylenders, transitioning them to formal finance.

Challenges & The Road Ahead

• Trust Deficit: Rural borrowers still prefer moneylenders due to personal relationships.
• Regulatory Uncertainty: RBI’s tighter fintech regulations (e.g., mandatory KYC) may slow growth.
• Over-Borrowing Risks: Easy digital credit can lead to debt traps, as seen in BNPL mismanagement cases.

While informal lending remains a challenge, fintech solutions are steadily shifting borrowers toward the formal economy.

Conclusion

The Monetary Policy Committee (MPC) decisions significantly influence India’s domestic economy, impacting key sectors such as banking, real estate, automobiles, MSMEs, agriculture, and consumer goods. However, the extent to which these sectors benefit from changes in interest rates depends on the efficiency of credit transmission, financial system accessibility, and overall economic conditions.

While formal sectors react to MPC policies through changes in lending rates and liquidity conditions, the informal banking sector remains largely unaffected due to its unregulated nature and reliance on cash-based lending. Despite policy rate reductions, millions of borrowers—especially MSMEs, small farmers, and daily wage earners—continue to rely on informal credit sources due to limited access to formal banking, complex loan application procedures, and a lack of credit history.

This highlights the urgent need for financial literacy and inclusion to enhance the impact of monetary policy on both formal and informal financial ecosystems. For MPC decisions to drive sustained economic progress, it is essential to strengthen financial inclusion and literacy. A well-informed borrower base with access to affordable formal credit can reduce reliance on informal lenders, improve credit transmission, and maximize the benefits of monetary policy for both individuals and businesses.