The monetary policy committee’s (MPC) policy announcement is due on August 6, with everyone waiting to hear from the RBI’s rate-setting panel after the surprises it delivered in the June meeting. Will this policy bring the final cut of this cycle or mark the start of an extended pause?
After looking at the latest CPI inflation reading and the trends in food prices for July, we thought it was a clear case for a rate cut under the MPC’s Flexible Inflation Targeting framework. The CPI inflation dipped to a 77-month low of 2.1 percent in June, led by the food and beverages (F&B) segment.
While monsoon spread has been quite uneven in June-July 2025, the core monsoon zone has seen adequate rainfall. Besides, the India Meteorological Department’s expectation of above-normal rainfall during August-September augurs well for sowing of kharif crops, which is likely to exceed last year’s level by a reasonable margin and the replenishment of the reservoirs, which in turn will be favourable for rabi sowing. The spatial and temporal distribution of rainfall, however, remains key, including a timely withdrawal of the rains to allow for harvesting.
Our assessment suggests that the July CPI inflation print is set to moderate further to a series-low of around 1.4 percent, though this is expected to be the bottom and the readings are set to normalise thereafter.
We estimate the FY26 inflation to average at 3.2 percent, with risks tilted slightly to the downside. We anticipate that the MPC will pare its baseline forecast significantly from the current 3.7 percent, which should have set the stage for further easing in August.
Trump tariff looms large
But the developments in the last few days have made the policy decision complicated.
On July 31, US President Donald Trump announced a 25 percent tariff on Indian goods, effective August 7, along with an additional undisclosed penalty tariff on account of India’s crude and defence purchases from Russia.
The base tariff (excluding the penalty) is higher than that for other Asian countries such as Vietnam, Bangladesh, Indonesia, and Japan, which can potentially weaken India’s position as a preferred sourcing destination. The Russia penalty would widen the gap further unless a trade deal, which brings down the base rate, is struck soon.
These developments pose a headwind to India's economy. We have lowered our FY26 GDP growth forecast by 20 basis points (bps) to percent from 6.2 percent. The extent of the Russia penalty could result in a further downside.
We expect MPC to moderate its baseline forecast for GDP growth below the extant 6.5 percent, which would further support the case for a rate cut.
To cut or not
However, these tariff-related developments have led to a slide in the rupee, which may dissuade the MPC from cutting rates immediately. While chances of a US Fed rate cut in September have brightened following the recent jobs data, there is a lack of clarity on the future trajectory thereafter, with uncertainty surrounding the impact of tariffs on inflation in the United States. These concerns may prompt the MPC to wait until October.
In our view, the CPI inflation prints will be benign in Q2 and Q3, while also printing materially lower than the MPC’s prevailing projections for these quarters, before witnessing a base-led uptick in Q4 and Q1 FY27. Thus, from an optics point of view, the future CPI inflation trajectory may not offer space to cut the policy rate by the time of the October 2025 policy review.
The 10-year G-sec yield has risen by 13 bps since the June MPC meeting. A 25-bps rate cut, which is perceived to be the final one in the cycle by the bond market, may well cause the yield curve to steepen. Over time, a relatively larger transmission by banks may result in a shifting of the demand for funds to the banking system from the bond market, as we approach the busy season.
While another cut may not hasten the elusive pick up in private capex, it would certainly benefit borrowers and give consumption demand a boost. An immediate rate cut would ensure that the benefits of the same accrue to the borrowers during the festive season. Hence, we believe that there is a case for a final 25 bps rate cut this week, though its probability has surely weakened from what we assessed two weeks back.
(Aditi Nayar is a chief economist at ICRA ratings.)
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