RBI's policy dilemma: To look at inflation or growth for rate action

A forward looking approach would prompt rate cut as H2 GDP growth likely to be softer

The consumer price index (CPI)-based inflation hitting an all-time low in October would encourage the six-member monetary policy committee (MPC) of the Reserve Bank of India (RBI) to cut the policy repo rate in its upcoming December 3-5 meeting. However, the July-September GDP growth, expected to be above 7 per cent, may act as a deterrent. 

The MPC has maintained a status quo on interest rates since June. The policy repo rate has been cut by 100 basis points (bps) since February. While cutting the rate by 50 bps in June, the central bank changed the policy stance to neutral from accommodative. In the October policy, there was consensus among MPC members for a status quo on rates, but two external members wanted the stance to be changed back to accommodative. 

A neutral stance would mean that the rate could go either up or down, or even remain unchanged. An accommodative stance implies the rate either goes down or stays where it is; it rules out rates going up. 

CPI inflation is expected to stay benign, aided by the GST rate cuts, so the RBI is not seen increasing the repo rate any time soon. A State Bank of India note said CPI excluding gold would remain negative in the next two months. Barclays has lowered its FY25-26 CPI inflation forecast by 30 bps to 2.1 per cent. The RBI has projected CPI inflation for FY26 at 2.6 per cent. RBI’s target for CPI inflation is 4 per cent, with 2 percentage point variation on both sides. 

“India’s CPI inflation trajectory calls for a strong case for decisive actions,” said Soumya Kanti Ghosh, group chief economic adviser, State Bank of India, in a report. “The higher growth numbers for Q2 and the October inflation print will pose a serious dilemma for the RBI for a rate action in December,” the report noted. 

During the October monetary policy, RBI has projected gross domestic product (GDP) growth for 2025-26 at 6.8 per cent; for Q2 at 7 per cent, Q3 at 6.4 per cent, and Q4 at 6.2 per cent. GDP growth in the first quarter (April-June) was 7.8 per cent. While GDP growth during the first half of FY26 stayed robust, estimates suggest it would soften during the second half. 

Economists at Barclays have estimated Q2 GDP growth at 7.4 per cent. While such a strong growth outcome would otherwise be seen as a deterrent to a rate cut, it is important to note that growth has peaked and H2FY26 growth is estimated to be lower than H1, they added. “For a forward-looking, inflation-targeting central bank, we believe the stage is set for the RBI MPC to deliver a 25 bps repo rate cut in the upcoming December meeting,” they said. 

The key risk to GDP growth in H2FY26 will be from tariffs, which will impact labour-intensive micro, small and medium enterprises  that constitute 45 per cent of goods exports, said Gaura Sen Gupta, chief economist, IDFC First Bank. The bank estimates GDP growth could fall by one percentage point over a 12-month period due to the 50 per cent US tariff. “Monetary policy space for rate cuts is limited; easing will depend on material downside risks to growth, or a failure of the consumption recovery to sustain beyond the festival season,” the bank said.