Rate Cuts on the Horizon: RBI Signals Confidence in Inflation Outlook

India’s central bank is poised to enact additional interest rate reductions in the coming quarters, underscoring a concerted focus on boosting domestic growth rather than exclusively containing inflation. This recalibrated stance distinguishes the Reserve Bank of India (RBI) from central banks in advanced economies, which remain more narrowly preoccupied with taming price pressures. In its February bulletin, the RBI noted that high-frequency indicators—such as vehicle sales, air traffic, steel consumption, and e-way bills—reveal a sequential uptick in activity during the second half of FY25, a trend expected to persist going forward.

Central to this outlook is the belief that headline inflation will stay within the mandated (2-6%) tolerance band, thus providing the latitude for more growth-friendly monetary policies. On February 7, the Monetary Policy Committee (MPC) voted to trim the benchmark repo rate by 25 basis points to 6.25%, the first such cut in nearly five years. While the MPC maintained a “neutral” policy stance—to preserve its ability to respond swiftly to global market volatility—it nevertheless signalled its readiness to support India’s economic momentum, which Governor Sanjay Malhotra views as paramount given inflationary trends converging toward the 4% target.

In the minutes of the latest MPC meeting, Malhotra reiterated that a lower policy rate is “more appropriate at the current juncture” now that inflation appears to be aligning with the RBI’s objectives. He emphasized the importance of forward-looking monetary policy in fostering growth, a position bolstered by several budgetary initiatives—particularly those focusing on agriculture—which he believes enhance price stability over the medium term and anchor inflation expectations. “The food inflation outlook is turning decisively positive,” Malhotra remarked, citing improving conditions that reduce the risk of near-term price spikes.

Malhotra, along with the other five MPC members—three from within the RBI and three externals—unanimously voted for the repo rate reduction. Despite this cut, the committee opted to retain its neutral stance. According to Malhotra, “This will provide the flexibility to respond to the evolving macroeconomic environment. By taking this logical course, monetary policy will be able to fulfil its mandate and play its part in the sustainable development of the Indian economy.”

The MPC’s decision reflects a collective consensus that growth is under pressure from both external and domestic factors. Some manufacturing segments—such as steel, garments, and leather—have signaled vulnerability to global trade disruptions and weaker export markets. The RBI bulletin also cautioned that a strong US dollar, spurred by US' economic resilience and shifting trade policies, could intensify capital outflows from emerging markets, elevate risk premiums, and exacerbate external vulnerabilities.

Against this backdrop, Deputy Governor M Rajeshwar Rao argued that the present juncture—characterized by headline inflation drifting closer to the 4% target—offers ample space to bolster growth. He was of the view that the rate cut  in conjunction with the fiscal measures announced in the FY26 budget, should give a fillip to aggregate demand conditions. Rao also welcomed the government’s reaffirmed commitment to fiscal consolidation, which he believes will help anchor inflation expectations over the medium term.

RBI Executive Director and MPC member Rajiv Ranjan echoed these sentiments, describing the policy rate cut in February as the logical progression of a process that began with ensuring sufficient liquidity for commercial banks. By sequencing these measures, the RBI aims to facilitate better transmission of policy rates into lending rates. The external members of the MPC, who had long advocated for lower rates, largely welcomed the move but offered varied perspectives on the degree of easing needed. Nagesh Kumar, for instance, suggested that a 50-basis-point cut would have sent a stronger signal to both domestic and international investors that India stands ready to do “whatever it takes” to revive economic growth. While Kumar ultimately supported the 25-basis-point reduction, he urged the committee to remain open to further normalizing monetary policy if global headwinds intensify.

Another external member, Saugata Bhattacharya, labeled a rate cut “the appropriate policy response at this point of the economic cycle,” highlighting that inflation’s downward trajectory could render the current policy rate excessively restrictive if left unchanged. Bhattacharya also endorsed the neutral stance, emphasizing the need for policy flexibility. Ram Singh, similarly, pointed to the FY26 budget's stimulus measures, which aim to spur demand. He cautioned, however, that unless borrowing costs are quickly reduced, private-sector capital expenditure—critical for job creation and long-term growth—might fail to materialize.

Meanwhile, the RBI bulletin’s “State of the Economy” article (which does not necessarily reflect the central bank’s official position) projects GDP growth of 6.6% in the January–March quarter of 2025 and 6.7% for 2025–26, aligning with the higher end of the government’s 6.3–6.8% range. It also expects inflation to moderate to 4.2% in the next fiscal year, barring risks from global market volatility, energy prices, or adverse weather events. 

This lends credence to our view that the RBI is likely to trim interest rates further over the course of 2025. We anticipate another rate cut in Q2 of 25bps.