Rate cut as expected; FY26 growth forecast slightly optimistic: Aditi Nayar

In its final scheduled meeting for fiscal 2024-25 (FY25), the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) cut the policy repo rate by 25 bps to 6.25 per cent, thereby instituting the first rate cut after a long gap of 56 months. The decision was aided by a shift in the voting pattern, with all the six members voting in favour of a cut, as against just two external members in the December 2024 meeting. Notably, the policy stance was kept unchanged at neutral, with a unanimous vote as well.

 

Both these decisions were in line with ICRA’s expectations, given the inflation-growth outlook, amidst palpable concerns stemming from global uncertainty and the untoward movements in the INR in the recent months. The MPC highlighted that the recent dip in CPI inflation and the expectations of a further moderation in FY26 to align with the target, along with subdued GDP growth expectations vis-à-vis FY2024 levels of 8.2 per cent, had opened up policy space to cut rates and support growth. Nevertheless, the tone of the document was somewhat cautious, with the Committee highlighting upside risks to inflation from uncertainties owing to global trade policies and adverse weather events.

 

The MPC expects the GDP growth to rise to 6.7 per cent in the next fiscal from the NSO’s estimate of 6.4 per cent in FY2025. It lowered its Q1 and Q2 FY2026 growth estimates by 20 bps to 6.7 per cent and 30 bps to 7.0 per cent, respectively, suggesting that growth outcomes are not expected to be as strong in the first half of the next fiscal, as was previously anticipated. Thereafter, it expects GDP growth to average at 6.5 per cent in H2 FY2026. Notably, it has acknowledged that household consumption will be robust aided by the tax relief in the Union Budget for FY2026.

 

We believe that the sizeable income tax relief, the impact of the rate cut on February 7 on EMIs and lower food inflation would augment urban demand, which has been rather lacklustre since the last few quarters. This could mitigate the looming downside risks stemming from the burgeoning global headwinds and instil confidence in our FY2026 estimate of 6.5 per cent, which had assumed modest tax cuts, 50 bps rate cuts, and a 12-13 per cent growth in Government capex to begin with.

 

ICRA believes that the MPC’s growth forecast for FY2026 is slightly optimistic; we expect the GDP growth to remain unchanged at 6.5 per cent in the next fiscal vis-à-vis FY2025. We will revisit our growth forecasts post the release of the Q3 FY2025 GDP print and revisions for Q1 and Q2, which are due at the end of this month.

 

On the inflation front, the Committee expects the CPI inflation to ease to 4.2 per cent in FY2026 from the projection of 4.8 per cent in FY2025, owing to a moderation in food inflation even as core inflation is forecast to rise. It anticipates the CPI inflation to average at 4.4-4.5 per cent in Q4 FY2025 and Q1 FY2026, and thereafter be centred in a narrow 20 bps range around the 4.0 per cent mark from Q2 through Q4 FY2026. 

The Committee’s CPI inflation estimate of 4.2 per cent for FY2026 is in line with our forecast for the same. This also validates our assessment that the aforesaid tax cuts are unlikely to be inflationary, and that the supply-side led relief on the food inflation front would possibly outweigh the uptick in core inflation, which the MPC expects to rise but remain moderate. 

Looking ahead, we believe that the growth-inflation outlook suggests that there is room for another 25 bps rate cut in either the April or the June 2025 meetings. The exact timing of the same would depend on the incoming data, global developments, and the movements in the USD/INR pair. 

Aditi Nayar is Chief Economist, Head- Research & Outreach at ICRA. Views are personal.