Focus on growth as inflation risks subside

Reserve Bank of India

Aditi Gupta, Economist, Bank of Baroda

RBI delivered a much-awaited rate cut after a gap of 5 years. This comes against the backdrop of subdued growth and receding inflation. The last time RBI cut rates was in 2020, at the onset of the Covid-19 pandemic. With a new Governor at the helm of the Monetary Policy Committee (MPC), the commitment to inflation targeting was reiterated, while also making the case for restoring the growth-inflation balance.

While the flexible inflation targeting framework decrees the MPC to ensure price stability, growth considerations are embedded in the mandate due to the inherent interlinkages between the two. In this respect, the MPC statement made an interesting observation that the “growth-inflation dynamics open up policy space for the MPC to support growth”, which suggests that there might be a greater emphasis on growth going forward.

Interestingly, RBI’s assessment noted the moderation in inflationary pressures due to improved agricultural prospects and seasonal factors. Our assessment indicates that there has been a gradual decline in prices of key vegetables, such as onion, tomato and potato, due to a steady increase in mandi arrivals. Recently, much of the gyrations seen in food inflation, and hence headline inflation, stemmed primarily from the volatility in the prices of these items. This does provide the necessary confidence that inflation is on track and likely to align durably with RBI’s target. RBI projections also indicate a inflation is likely to decelerate progressively in the coming quarters. In this respect, another point to note is that the statement suggested that there will be a greater focus on the 2-6% inflation band, rather than the 4% target. Hence, it does appear that in the absence of any adverse shocks, RBI is comfortable with the inflation averaging close to the 4% target, providing it flexibility to support growth.

On growth, RBI forecasts suggest that while growth is likely to rebound from a low of 5.4%, it remains “lower than last year” which necessitated the need for support. It is important to note that RBI projects GDP growth of 6.7% in FY26, which is lower than the long-term trend rate. This raises the likelihood of further policy support. At the same time, a neutral stance gives RBI the flexibility to remain watchful of the evolving global dynamics and financial sector volatility.

Notably, the prelude to the rate cut was already set up late last month, when the RBI announced measures to ease domestic liquidity conditions. Since then, domestic liquidity has improved with the average liquidity deficit at ~Rs. 70,000 crore as of 6 Feb 2025, from a peak of Rs. 3.1 lakh crores a week earlier. By addressing the liquidity stress in the banking sector, RBI ensured that there is enough liquidity in the system to ensure smooth transmission of any subsequent rate cuts.

Overall, we believe that today’s RBI policy has set the stage for more rate cuts with a possibility of 2 more rate cuts in this cycle. A close coordination between monetary and fiscal policy is likely to put the domestic growth recovery in a fast lane. This in turn, hinges on the assumption of a normal monsoon and limited impact from global developments which can derail the progress in achieving the optimal balance of growth and inflation.

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