RBI has downgraded its growth forecast by 80 basis points in four months. This has rattled markets.
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Prime minister Narendra Modi made headlines when he emphatically asserted that India’s rapid growth was the only certainty amidst global instability. He said this in an auditorium comprising industry captains at the Advantage Assam 2.0 summit on February 25.
Investors are waiting for the December-ended quarter GDP growth print for reassurance. In the previous quarter, domestic economic growth slumped to a seven-quarter low of 5.4 percent from 6.7 percent in the first quarter. All sectors, excluding agriculture and services, reported degrowth. Against this backdrop, the Reserve Bank of India (RBI) has lowered its growth outlook for FY25 from 7.2 percent in its October 2024 policy to 6.6 percent in its December policy to 6.4 percent in the February one.
In other words, the RBI has downgraded its growth forecast by 80 basis points in four months. This has rattled markets. The RBI has projected GDP growth for FY26 at 6.7 percent.
However, many economists are sceptical and predict a growth slowdown with tepid private investment, mixed consumption demand, and high global trade uncertainty. “Growth is likely to continue to disappoint,” says Nomura’s chief economist Sonal Varma. The foreign brokerage firm sees GDP growth at 5.9 percent for FY26.
The government’s tax bonanza for the middle-class and the central bank’s 25 basis points rate cut have not quelled market fears of an economic slowdown. As a result, the stage is set for further rate cuts of up to 50 basis points even as a weak rupee, trade wars, and inflation jostle for attention in an increasingly volatile global economy.
The recently released minutes of the first monetary policy meeting headed by new RBI Governor Sanjay Malhotra suggest the rate-setting panel has prioritised growth as the antidote to navigate multiple headwinds facing the economy.
“We could be more ambitious and target a 50-basis point cut [in the February meeting],” Nagesh Kumar, director and CEO, Institute for Studies in Industrial Development, remarked. “It would send a signal to the markets and private investors within and outside the country that India is serious and would do whatever it takes to revive economic growth momentum.”
Rupee Meltdown
“Most MPC (monetary policy committee) members believe that policy rates should not be held hostage to the currency,” says Varma.
Case in point: Rajiv Ranjan, executive director, RBI, argued that India’s forte is its immense growth opportunities and interest rate defence of exchange rate could turn out to be counterproductive. “There is a need to preserve the high-growth momentum over the medium term, necessitating monetary policy to use various policy instruments, including liquidity injection, to reinvigorate growth,” he said. “Capital flows to India are driven more by its distinctive growth story rather than interest rate differentials.”
Similarly, Saugata Bhattacharya, economist, and one of the three external MPC members, cited the findings of a study to argue that the estimated impact of a 25-basis points rate cut on rupee depreciation was not worrisome at this stage. “A possible repercussion of policy easing might be an increase in currency volatility and a depreciation of the USD-INR pair. This might not be a major cause for concern,” he explained. “A recent study estimates that if INR depreciates by 5 percent, CPI ‘inflation could be higher by around 35 bps’ while GDP growth ‘could edge up by 25 bps through short-term stimulation of exports’.”
Ram Singh, director, Delhi School of Economics, also alluded to the risk of higher outflows because of lower interest rate differentials. But he believed this was a low probability scenario. Furthermore, he points out, developed markets have reduced rates, and this provided India room to reduce policy rates without adversely affecting the foreign exchange flows.
“Foreign exchange concerns were cited, but the need to focus on growth outperformance was emphasised,” says Madhavi Arora, chief economist, Emkay Global Financial. “It does seem as though the RBI has now loosened its reins to some extent on FX (foreign exchange) under the new governor.”
The rupee slumped to 87.23 against the US dollar on February 25.
Varma expects the MPC to cut the repo rate in the April meeting too. “They don’t see currency weakness as a hurdle to rate cuts,” she says. “There is less worry on rate cuts leading to currency depreciation, but flexibility is retained due to global uncertainties.” Nomura has pencilled rate cuts to the tune of 75 basis points this year.
Arora expects a shallow rate cut cycle of another 25 to 50 basis points with a possible easing of regulatory measures in the coming months. “Delay in implementation of the ensuing Liquidity Coverage Ratio and project financing and Expected Credit Loss provisioning, at least till end-FY26, should also be viewed as easing by stealth,” she adds.
Also read: The economy needs more than a rate cut
Trump 2.0
The possible inflationary impact of tariffs surrounding trade policies under Trump 2.0 has been a red flag. In contrast to the rather synchronous financial tightening across countries, Ranjan notes, there is now a hesitant, guarded, divergent and discontinuous rate cut cycle under progress. “Uncertainty has been high due to elevated trade fragmentation concerns, persistent geopolitical tensions and slowing disinflation,” he observes.
Kumar highlights widespread fears of the world economy going into a deep and prolonged slump with such protectionist trade policies. “The case for supporting growth cannot be overemphasised,” he states.
Bhattacharya was also wary of the possible spillovers of frictions in global trade and protectionist policies. He cautioned that a global growth slowdown led by disruptions in trade linkages and uncertainty about responses of global central banks might further complicate domestic policy choices. “The most significant near-term risk of accelerating policy easing at this juncture is renewed volatility in external financial conditions,” he notes. But he voted for a 25-basis points rate cut because he believed it was the appropriate policy response at this point of the economic cycle.
Developments in global trade and ensuing financial market volatility will determine the rate trajectory. While the rate-setting panel will remain data dependent, the six-member committee doesn’t want these uncertainties to derail domestic growth. “Definitely, our decisions are guided by domestic growth-inflation trade-offs, while remaining attentive to global developments,” Ranjan adds.
RBI Governor Malhotra agreed that rising uncertainties on global financial markets and trade policy front, coupled with the continuing risk of adverse weather events, pose risks to the inflation and growth outlook. “We need to be watchful of how these forces play out,” he said.
Inflation
The RBI has forecast CPI inflation for FY25 at 4.8 percent with Q4 at 4.4 percent. As per its estimates, retail inflation is likely to cool down to 4.2 percent in FY26 with Q1 at 4.5 percent; Q2 at 4 percent; Q3 at 3.8 percent; and Q4 at 4.2 percent.
“I am now cautiously optimistic about the downward trajectory of inflation,” Bhattacharya said. “I believe that, at this point, the required policy response on the inflation—growth trade-off—even factoring in significant margins of error from emerging risks seems skewed in favour of the latter.”
Unlike the former RBI governor who reiterated his objective to pin CPI at 4 percent for a pivot in policy rates, the minutes of the February MPC meeting show that the rate-setting panel is more flexible. MPC members were of the view that a 25-basis points rate cut would complement the capex and tax cuts announced in the Union Budget on February 1.
“It is now the monetary policy’s turn to support economic growth through a rate cut,” Kumar said. “A rate cut could help to spur demand for investment in housing and durable consumption goods and could support private investment by lowering the cost of capital.”
Ranjan agreed: “Well-coordinated fiscal and monetary policy working in tandem could undoubtedly generate improved outcomes in terms of better growth-inflation balance.”
M Rajeshwar Rao, deputy governor, RBI, pointed to the shift in the domestic growth inflation balance since the December 2024 policy. “While the inflation registered sequential softening, growth outcomes were weaker,” he observed. “Heightening uncertainties, emanating from the global financial markets and trade policies, too, cloud the outlook for domestic growth and inflation.”
Suvodeep Rakshit, chief economist, Kotak Institutional Equities, explains that softening inflation allows room for a rate cut. “While the January inflation data was not available at the time of the MPC meeting, the December headline inflation print of 5.2 percent, along with core inflation below 4 percent, has enhanced the expectations of a downward inflation trajectory,” he reasons. Besides food inflation has been gradually sliding down.
Moreover, according to the minutes of the Federal Open Market Committee meeting in January, the US Federal Reserve is cautious about the upside risks to its inflation outlook: “Many participants, however, emphasised that additional evidence of continued disinflation would be needed to support the view that inflation was returning sustainably to 2 percent.”
This is partly because of the immigration policy and changes in trade policy. “Fed officials remain cautious about adjusting interest rates, emphasising the need for further progress on inflation before making any changes,” JM Financial analysts say in a note. A restrictive US monetary policy will compound growth complexities for emerging markets like India.
The RBI held its first monetary policy meeting of the calendar year from February 5 to 7. At the meeting, the rate-setting panel unanimously voted to reduce the repo rate to 6.25 percent from 6.5 percent while retaining a neutral stance. This was the central bank’s first rate cut in nearly five years.