The case for RBI rate cuts: Space, need, and timing considerations

As the Monetary Policy Committee of the Reserve Bank of India (RBI) meets, we believe there is a case for resuming rate cuts, based on space, need, and timing considerations. 

Space for easing 

The inflation backdrop provides ample room. Core inflation has edged up, but mainly driven by gold prices. Underlying inflation measures such as the trimmed mean and super core are closer to 3 per cent. Even the year-ahead inflation projections showing an uptick above 4 per cent, largely reflect an unfavourable base rath­er than emerging price pre­ssures. The upcoming GST rati­onalisation should have a dis­inflationary impact of 0.3-0.4 per­centage points, but this is lik­ely to be a one-off. After adjusting for the GST impact, inflation is still undershooting the target. 

Need for support 

Q1 GDP (gross domestic product) growth surprised positively at 7.8 per cent, but this was amplified by low deflators, and alternate measures suggest that the output gap is negative. The slowdown in nominal GDP growth has broa­der macro implications for fiscal tax collections, and corporate decisions on both investments and wage growth for workers. 

Moreover, higher tariffs are likely to more than offset the boost from GST cuts. GST reforms are positive for medium-term growth, but they mainly affect consumption timing, whereas the more fundamental driver of consumption is jobs and income growth. Lower prices will boost real disposable income, but some of this could be saved, rather than consumed. 

The impact of US tariffs, meanwhile, is already visible in August trade data, and the labour-intensive sectors are facing a significant squeeze on profit margins, which could spill over to employment and investment over time. 

The government has anno­unced personal income tax cuts, GST cuts and frontloaded capex, but it also intends to maintain the fiscal deficit at 4.4 per cent of GDP, which means that the net fiscal impulse is not as large. 

Overall, we expect GDP grow­th to moderate from 7.5 per cent in H1 to closer to 6 per cent in H2 FY26, suggesting the output gap will likely remain negative. 

Timing is right 

Recent US actions, such as the higher H-1B visa fee and tariffs on pharmaceuticals, are a clear sign that there are limits to relying on external demand, and the focus must be on boosting domestic demand. 

The upcoming festival season and start of the busy credit cycle make the timing opportune. While consumption growth is necessary for revival, it may not be sufficient without a complementary reduction in the cost of capital. 

For a virtuous cycle between consumption and investment, there is a case for coordinated fiscal-monetary policy, alongside structural reforms to maximise effectiveness, rather than a staggered approach. Given the lags in monetary policy transmission, there are limited gains from waiting. 

Risk-reward 

From a risk-reward perspective, rate cuts could provide a positive surprise that enhances monetary transmission, while risks ap­p­ear contained given below-tar­get inflation, further Fed rate cuts, and manageable currency risks. 

With space available, the need for support, opportune timing and favourable risk-reward, the case for resuming rate cuts appears compelling. While this alone won't address all challenges, it represents an important step in boosting domestic demand and offsetting the incoming external risks. 

 

The writer is the chief  economist (India and Asia ex-Japan) at Nomura