RBI at a crossroads: Will it push the pedal on rate cuts?

CPI-based inflation has stayed below the RBI's medium-term target of 4 percent for the third consecutive month. In fact, April surprised on the downside with the year-on-year CPI for April 2025 recorded at 3.16 percent.  The inflation forecast is likely to be revised down by 20-30bps and there are no material upside risks to inflation. Global cues are pointing to risk-off. Industrial and agri commodities have significant inventory and prices are likely to be muted. Fuel inflation will remain stable. Domestically, food inflation has historically been a joker in the pack, but it will likely be subdued, albeit on a high base.

The impact of the tariffs creates a disinflationary scenario in countries that export to the US. Goods that were initially exported have faced a tariff hurdle and are now being distributed in the country of production. A supply glut can possibly be disinflationary, but then who knows in the TACO trade world. Our base case remains an inflation regime that is largely under control.

When Trump unleashed the tariff war, it resulted in heightened trade uncertainty and dismantling of the international trading order, which has weighed in on growth expectations across economies. The global economic outlook is uncertain as growth slows across major economies including the US, Europe, and Asia. A synchronized slump is evident in rising inventory levels and weak global demand.

When optimism was high on Trump being re-elected, the strength of the dollar rattled currencies, and resulted in the rupee hitting a lifetime low against the USD. The tide has turned. The U.S. Dollar Index (DXY), which measures the value of the USD against a basket of six major currencies, has weakened while the INR has been clawing back lost ground. The RBI’s intervention, though a costly exercise, is no longer needed and will likely not come before significant further depreciation. In the previous Governor’s regime, the trilemma seemed impossible. Today, more variables are pointing towards creating an environment of easing.

RBI’s bumper dividend of Rs 2.7 lakh crore has surpassed the Union Budget estimates and will ease the fiscal deficit. Again, this means that fiscal can also support monetary reflation today more than in the past. Fiscal has to slow; monetary needs to step up.

The central bank is also expected to slow its liquidity infusion, which it has aggressively done over the past six months, via a cut in its cash reserve ratio (CRR), secondary market debt purchases, foreign exchange swaps, and open market operations (OMOs). Liquidity is now comfortable, but easing of liquidity is a direct sign of an accommodative bent of mind.

At the same time, the growth forecast has been reduced to 6.5% from 6.7%. Some high-frequency data on the ground is turning now but still isn’t broad-based. Protecting domestic growth amidst global turmoil is important.

The latest RBI report noted that a rise in input cost pressures in the manufacturing sector, global protectionism in trade policies, geopolitical tensions, and subdued demand pose risks to India’s economic growth. At this juncture, policy coordination between the government and the central bank is what is crucial.

The RBI's Annual Report for 2024-25 suggests a growth-supportive monetary policy stance. The global and domestic environment support monetary reflation. We believe the terminal rate can be closer to 5.5–5.75%. This is the time for RBI to act, and to act strongly.