RBI puts economic growth on the front burner

The RBI can keep domestic growth as the primary focus especially as supply shocks fade.

By Rahul Bajoria

After the pro consumption pivot the government made in its budget, the Reserve Bank of India (RBI) too has come to the party. Indeed, after two years of keeping rates on hold at 6.5 percent, the monetary policy committee in the first meeting under Governor Sanjay Malhotra did not disappoint and delivered a monetary stimulus in the form of a 25bp (basis point) rate cut, supplementing the liquidity injections it had undertaken two weeks ago. The decision to cut rates and to keep the stance at neutral was unanimous as well.

After a period of tackling contradicting objectives, RBI has finally found a window of opportunity, where the weakness in economic data around growth and inflation provides a base for policy easing, while seeing some needed adjustment on exchange rate. The softer implementation of universal tariffs by the US administration also provided some tactical space for RBI to prioritize domestic growth, both by injection of durable liquidity, and space to cut policy rates, in our view.

On the growth front, the need for monetary support remains high. After the 5.4 percent growth shocker in Q2FY25, high frequency indicators for H2FY25 are still showing mixed trends. Indeed, rural indicators such as agriculture production, sowing activity, and tractor sales are showing resilience, while urban indicators are showing pockets of stagnation, in particular consumption and credit growth remains weak across sectors.

Further, the festive momentum gathered in October and November has lost some grip, with signs of a demand slowdown leading to overall weakness in consumption and aggregate demand. The fiscal support from Budget 2025-26 in the form of tax cuts could spur consumption but the multiplier effect may not be as strong. The limits to fiscal spending may constrain the government from taking further measures to stimulate consumption. These mixed signals have made the RBI keep FY26 growth only a tad higher at 6.7 percent, in line with the Ministry of Finance compared to the First Advance estimates for FY25 at 6.4 percent.

On inflation, the temporary spike in perishable food prices is quickly reversing, and food inflation, which had been elevated for some time, looks much more in control. For January and February, our tracking estimates show a steep deceleration in price pressures, leading to a CPI projection for January at 4.4 percent. Further, with core inflation staying below 4 percent for over a year, the underlying demand side price pressures remain weak, and may not exert considerable inflationary pressures in the near term. The medium-term trajectory of headline inflation as well for 2025 is looking relatively benign and could even post sub-4 percent prints in the latter half of the year, with the FY26 inflation print expected to average 4.2 percent as per RBI forecasts, despite a weaker rupee.

Overall, a clear shift is now visible, with the RBI prioritizing growth given its various policy constraints. This has been achieved by letting the rupee become more market determined, and the tightness in liquidity conditions has been met with injection of liquidity through various tools. The global policy backdrop, commodity prices, and outlook for capital flows do not provide significant space to manoeuver, but still with inflation declining and the rupee adjusting to more realistic levels, the macro imbalances are reducing, even if financial markets remain fragile in sentiment. Once market sentiment stabilizes and external sector compulsions get taken care of, the RBI can keep domestic growth as the primary focus especially as supply shocks fade. In the April MPC, subject to global factors, the base case should be for another 25bp rate cut, bringing the Repo rate to 6 percent.

(Rahul Bajoria is Head of India and ASEAN Economic Research, BofA Securities.)

Views are personal and do not represent the stand of this publication.