RBI moves in the right direction but global uncertainty can change plans

RBI has done well to support growth.

By Rajnish Gupta 

The Reserve Bank of India's (RBI) decision to cut the policy repo rate by 25 basis points to 6.25 percent marks the first reduction in almost five years. The reduction has come in the backdrop of GDP growth rate of 5.4 percent in the second quarter of FY25. While the economic growth is expected to recover in the current year and end up near 6.5 percent, however, it will be lower than the 7 percent plus growth in FY23 and FY24. The rate cut is welcome and will support economic growth. By lowering borrowing costs, this move strengthens India's growth outlook and reinforces a stable, pro-investment environment.

It is acknowledged that private capital expenditure and manufacturing growth need to accelerate. However, given fiscal constraints, the government's ability to further increase capital spending is limited, making it essential to stimulate private investment for sustained economic momentum.

Although a 25 basis point cut is a modest change, it serves as a positive incentive for investments. Additionally, by lowering the cost of housing loans tied to floating interest rates, the rate cut will provide homeowners with extra disposable income, potentially boosting consumer spending.

Consumer inflation is on a downward trajectory and is projected at 4.4 percent for the last quarter of FY25. Food products have a high weightage of 45.9 percent in the consumer price index and volatility in food prices has been the biggest driver of inflation. Expectation of good kharif production, easing in vegetable prices and favourable rabi crop prospect on the back of normal monsoons next year gave confidence that inflation would not flare up.

For FY26 inflation is projected at 4.2 percent, only slightly higher than 4 percent.  Aside from the current change, the attendant question is with regard to possible future stance. RBI has said that they are taking a neutral stance, and future actions would depend on a fresh assessment of macro-economic outlook. Both local and global factors could impact future stance.

Firstly, we are currently in a period of global policy uncertainty with regards to trade, tariffs, and the conduct of macro-economic policies by advanced economies.  The global disinflation is stalling due to service inflation. Expectations on the size and pace of rate cuts in the US have receded and the US dollar has strengthened. Though the Indian economy is strong and resilient and there is stability in the Indian banking sector, however, there has been a 3.2 percent depreciation in the rupee since the US elections in November 2024. This underscores that India is not immune to global headwinds. While India has reserves of $630 billion and a low current account balance, the performance of the rupee would be watched in the coming months. Change in value of the rupee also impacts inflation in India.

Secondly, ability to control food inflation would be impacted by weather conditions and changes in global energy prices. Adverse weather conditions that result in a supply side shock could impact future inflation. In addition, India continues to be dependent on imports for meeting its energy needs. Any unanticipated increase in energy prices could also impact future stance.

To conclude, RBI has done well to support growth, as in its assessment the inflation rate is trending downwards. However, we need to watch both the global and local conditions for taking a view on the future stance.

(Rajnish Gupta is Partner, Tax and Economic Policy Group, EY India)