Benign CPI inflation revives rate cut hopes, RBI to weigh growth data before decision

Reserve Bank of India

India’s retail inflation is likely to dip further in October and may remain below the Reserve Bank of India’s (RBI) lower tolerance threshold for a second consecutive month, potentially igniting hopes for another rate cut in the December monetary policy.

Economists, however, believe that the Monetary Policy Committee (MPC) will act cautiously on the key policy rate, and take its cue from growth data rather than give more weightage to inflation.

If a rate cut happens in December, it will be the first reduction by the central bank’s status quo in last two policies. The RBI has so far reduced repo rate by 100 bps from 6.50 percent to 5.50 percent.

Aditi Gupta, Economist at Bank of Baroda said inflation is expected to moderate further in October, primarily driven by a sharp correction in food prices. “Prices of key vegetables such as onion, tomato and potato have seen a sustained decline this year, which is contributing significantly to the moderation in food prices and headline inflation,” she said. The inflation data in India is released with short lag, and the October data will be released on November 12.

Gupta added that the pulses category has witnessed a deflationary trend, supported by improved sowing and supply conditions. “The broad disinflation we are seeing is supply-driven. Core inflation, which is more reflective of demand-side pressures, continues to remain above 4 percent, indicating that underlying demand conditions are robust.”

“If risks to growth from higher tariffs continue to liner on, the RBI is likely to cut the policy rate by 25 bps,” Sakshi Gupta, Economist at HDFC Bank said.

Easing Inflation: Sign of Weak Demand?

Inflation cooled to 1.54 percent in September, the lowest reading in over eight years, easing from a two-month high of 2.07 percent in August.

Economist said the recent easing of inflation cannot be interpreted as a sign of weak demand or an imminent growth slowdown.

“While inflation remains below the RBI’s target, it is evolving broadly in line with the central bank’s expectations. This gives the RBI policy space to consider a rate cut, but the decision will be contingent on the second-quarter GDP figures, which are due before the December policy meeting,” Aditi Gupta said, cautioning over the recent drop in prices could prove transitory.

Sakshi Gupta said the October inflation dip will likely be influenced by one-offs such as lower GST rates. “The decline in inflation in October is partly led by GST rate reductions, which represent a one-time price adjustment rather than a sustained disinflationary pressure.”

Too Low Inflation is Not Ideal

According to economists, inflation staying lower for a longer period is not necessarily positive for the economy, as it discourages spending by consumers and is viewed as a cue for further easing, leading to lower economic activity. This might postpone consumers’ buying decisions, thereby weighing on growth. A prolonged phase of low inflation also increases the risk of deflation.

“Very low inflation for an extended period is not ideal for growth as it can have an adverse impact on wage growth and more broadly nominal growth,” Sakshi Gupta said.