RBI can back growth with ease; urban demand is low but so is inflation

While the latest gross domestic product (GDP) data has exceeded market expectations, the Reserve Bank of India (RBI) is likely to continue the rate-cutting cycle in the upcoming Monetary Policy Committee (MPC) meeting. Let’s look at domestic growth, inflation and global dynamics to better understand factors that will have a bearing on the RBI’s monetary policy decision.

 

The GDP growth has improved sharply to 7.4 per cent in Q4 (January-March, 2025), taking the full-year growth for FY25 to 6.5 per cent, in line with the National Statistics Office’s second advance estimate. A deeper dive into the GDP data shows that there are pockets of high growth, but some areas of concern persist. There has been a sharp pickup in investment growth in Q4 to 9.4 per cent. This would have been mainly led by government capex, as a sharp rebound in private investment remains elusive. Moreover, there has been a moderation in private consumption growth to 6 per cent in Q4 FY25, from an average of 7.6 per cent in the previous three quarters.

 

Another point to note is that the Q4 GDP has been supported by factors like a sharp reduction in imports and a fall in subsidies, which are not necessarily indicative of growth momentum. If we look at sector-wise growth for the full year, we find that agriculture, services, and the construction sector have recorded good growth, but manufacturing growth remains feeble.

 

Overall, GDP growth has moderated to 6.5 per cent in FY25 from an average of 8.4 per cent in the previous two years. Going forward, there are looming risks to the growth outlook. The main risk emanates from global uncertainties. The International Monetary Fund has lowered global GDP growth projection for 2025 to 2.8 per cent from its previous estimate of 3.3 per cent, given the global trade war and geopolitical concerns. India would be relatively less impacted by the global trade slowdown given its lower trade exposure and the healthy performance of services exports. However, India will also feel the pinch of the global slowdown and volatility in capital flows.

 

On the domestic front, the concern is relatively weak urban demand. Consumption spending will get some boost from factors such as the prospects of a good monsoon, lower income-tax burden, and soft inflation in FY26. However, there is a risk of the urban job market getting adversely affected by global uncertainties and consequent repercussions on India’s exports. Private investment in the economy, which has been slow to pick up, may also get adversely impacted by global uncertainties. We expect India’s GDP growth at around 6.2 per cent in FY26. Global factors will have a strong bearing on India’s growth outlook. While global trade concerns have somewhat abated in the last few weeks as the US has postponed the imposition of reciprocal tariffs, it is still a very uncertain scenario.

 

Inflation will remain comfortable. Consumer price index (CPI)-based inflation has remained below the RBI’s 4 per cent target for the past three months. Food inflation has decreased to 2.1 per cent in April, from a peak of 9.7 per cent in October 2024. The prospects of a healthy monsoon are likely to keep food inflation under control. Moreover, weak global growth will help contain international prices of commodities, including crude oil. The pressure on the rupee has also abated, which will help keep imported inflation under control. Overall, we expect average CPI inflation to remain around RBI’s 4 per cent target in FY26.

 

As far as global markets are concerned, the US Federal Reserve has a challenging task given the adverse impact of reciprocal tariffs on growth and inflation. The US Fed is likely to cut policy rate by another 50 basis points (bps) in the second half of 2025. The currency dynamics have flipped in the last few months. The US dollar is under sustained pressure, having weakened by around 9 per cent so far this year. Interestingly, US yields have been rising amidst uncertainties,  narrowing the interest rate differential with India.

 

Despite global headwinds, India’s external position remains resilient. Foreign exchange reserves have increased by $52 billion year-to-date, reaching $693 billion (as of May 23). The current account deficit (CAD) is also expected to remain manageable at around 0.9 per cent of GDP in FY26. On the external front, healthy services exports and softer Brent crude oil prices are key positives. Hence, the RBI does not need to worry about any sharp weakening pressure on the rupee even as it cuts policy rates.

 

The RBI has ensured abundant liquidity in the system through liquidity management tools. Average banking system liquidity stood at a surplus of ₹1.7 trillion in May. This is even higher than the ₹1.4 trillion surplus in April. This has resulted in the call rate hovering around 25 bps below the repo rate in the last two months, implying an effective easing of 25 bps. We expect the central bank to go for a further 50 bps rate cut in 2025, including a 25 bps cut in the upcoming meeting.

 

 

The author is chief economist, CareEdge Ratings