Rate cut could be a close call as RBI eyes lower CPI, steady growth view

RBI will pare CPI inflation projection again, but might not change growth estimate for now; dovish undertone likely

After a one percentage point cut in the policy repo rate in three tranches — between February and June — the Monetary Policy Committee (MPC) of India’s central bank left the rate unchanged at 5.5 per cent in August. The “neutral” monetary policy stance also stayed put. Both decisions of the Reserve Bank of India’s (RBI’s) six-member rate-setting body were unanimous. 

While reducing the policy rate by half a percentage in June, the RBI had changed its stance from “accommodative” to “neutral”. 

In August, the RBI also left its gross domestic product (GDP) growth estimate for 2025-26 (FY26) unchanged at 6.5 per cent, but pared its projection for the consumer price index (CPI)-based inflation rate for the year sharply — from 3.7 to 3.1 per cent. In June, it had reduced it from 4 per cent to 3.7 per cent. 

Announcing the last policy, RBI Governor Sanjay Malhotra said the current macroeconomic conditions, outlook and uncertainties called for a continuation of the current policy rate and a wait for further transmission of the “frontloaded” rate cuts to the credit market and the broader economy. 

The uncertainties surrounding the tariff tantrums have been continuing. What can we expect from the MPC on October 1?

 

Before we get into that, let’s look at what has changed since the last policy.

 

In mid-September, the US Federal Reserve cut its benchmark interest rate for the first time since December 2024, and signalled that more cuts were likely this year. Matching Wall Street’s expectations, it went for a quarter percentage point cut, putting the target range for its main lending rate at 4-4.25 per cent.

 

Two more quarter percentage point cuts are expected this year, but the Fed chairman has made it clear that further cuts are “not on a pre-set path”. This is despite the fact that “the balance of risks has shifted” towards the employment side of the Fed's mandate instead of inflation, which was the case earlier.

 

After the RBI’s last monetary policy, the yield on the 10-year government bond rose 9 basis points, to 6.42 per cent, as the market saw an end of the easing cycle. One basis point is a hundredth of a percentage point. The trend continued till the last week of August, when the 10-year bond yield touched 6.65 per cent at intra-day trading before closing at 6.6 per cent – the highest this financial year. Last Friday, it closed at 6.5 per cent.

 

The Rs 6.77 trillion gross government borrowing calendar for the second half of the current fiscal year, released last week, should have a positive impact on the yield in the runup to the policy. In sync with market expectations, the share of ultra-long-end papers in the borrowing programme has been reduced. Besides, extending the weekly auctions to March, instead of February, as has been the tradition, will also ease the supply pressure to some extent.

 

Meanwhile, the rupee, which traded at 87.73 a dollar on the day of the last policy, closed at 88.72 last Friday. Early last week, it hit a new low against the dollar – 88.8 in intra-day trading, before closing at 88.755.  A weakening rupee may not be a big issue at this juncture since in the trade tussle, a weaker currency helps – unless crude price jumps.

 

For the record, ahead of the action-packed June policy, when the RBI cut the repo rate by half a percentage point, reduced the banks’ cash reserve ratio by 1 percentage point to release Rs 2.5 trillion into the system (between the first week of September and the last week of November), and changed the policy stance from accommodative to neutral, the 10-year bond yield was 6.19 per cent and one dollar fetched Rs 85.63.

 

India’s economy grew at a faster-than-expected annual rate of 7.8 per cent in the quarter ending June, picking up from 7.4 per cent in the previous three months. The growth, which surprised many economists, was propelled by the manufacturing, construction, and service sectors.

 

Retail inflation edged up to 2.07 per cent in August, after a 1.55 per cent rise in July 2025, the lowest since June 2017, and below the lower end of the RBI’s flexible inflation target band of 2-6 per cent.

 

What’s the outlook on growth and inflation?

 

The September issue of the monthly RBI Bulletin exudes optimism over the state of the economy. It sees a sustained uptick in consumption demand and potential for a “virtuous cycle” of higher investments and stronger growth impulses, “overcoming persistent global uncertainties”. It hails the “landmark reforms" in the goods and services tax (GST) structure as a key driver for consumption growth, ease of doing business and lower retail prices.

 

Besides GST rate cut, the other contributing factors for growth that the publication outlines are the transmission of the front-loaded monetary policy easing measures, income tax reliefs, and measures to augment employment, the RBI publication has outlined.

 

Given the optimism, why would one expect a quarter percentage point rate cut on Wednesday? A Diwali gift from the RBI, maybe? Perhaps the view is that the picture isn’t as rosy as many think. The 8.8 per cent growth in nominal GDP in the June quarter, down from 10.8 per cent in the previous quarter, is one reason for this view. This is a three-quarter low; in the corresponding quarter of the last fiscal year, nominal GDP had grown at 9.7 per cent.

 

Nominal GDP is the value of all finished goods and services produced within an economy and measured at current market prices. Unlike real GDP, nominal GDP includes changes in prices caused by inflation. A dip in inflation impacted the GDP deflator, which is now 0.9 per cent, its lowest in 23 quarters. This is the reason behind the fall in nominal GDP. Be that as it may, many believe that nominal GDP may be a better indicator of economic growth at this point of time, given the slowdown in direct taxes and bank credit, among other factors.

 

The cut in GST is likely to push consumer price index (CPI)-based inflation down to below 2 per cent in September and to less than 1 per cent in October. The new inflation basket for measuring the CPI inflation, expected to take effect in February 2026, is also likely to have a positive impact on inflation. Using 2024 as the base year, and incorporating data from the FY23 Household Consumption Expenditure Survey, the weighting diagram is being updated, where food is expected to have less weightage than its current level of 45.86 per cent.

 

This means, the RBI will once again pare its inflation projection. In the August policy, it had projected CPI inflation for FY26 at 3.1 per cent (2.1 per cent in the second quarter; 3.1 per cent in the third; and 4.4 per cent in the fourth). The projection for the first quarter of 2027 is 4.9 per cent. It will revise all figures downwards.

 

Will it tweak its projection for real GDP growth? At this point, it is unlikely. In August, it had left its projection unchanged – 6.5 per cent for FY26. I think the RBI will stick to that for the time being.

 

What is it expected to do on the rate front? Well, with inflation falling, the real interest rate – or the gap between the repo rate and inflation – will widen, at least for the next few months. So there’s scope for a quarter percentage point rate cut.

 

The question is: Will the MPC go for it now or wait for its next meeting in December? By then, tariff uncertainties might settle and a clearer picture could emerge for growth. Also, GDP for the second quarter of FY26 will be known, and the impact of GST cut on inflation will be visible. If the RBI opts for the status quo this week, expect the tone of the policy to be dovish. 

The writer is an author and senior advisor to Jana Small Finance Bank Ltd.  His latest book: Roller Coaster: An Affair with Banking. To read his previous columns, log on to www.bankerstrust.in. X: @TamalBandyo