Future trajectory: Policy rate cut uncertain despite cooling inflation

The data released last week showed that the consumer price index-based inflation rate declined to a 99-month low of 1.54 per cent in September. This has increased market expectations of a policy repo- rate cut in the December meeting of the Reserve Bank of India’s (RBI’s) Monetary Policy Committee (MPC). The minutes of the last MPC meeting, also released last week, showed that members were of the view that the space for policy support had opened up. However, the decision at the December MPC meeting will depend on a range of factors, and the incoming data until then will be crucial in shaping the consensus view. 

Food prices have largely driven the sharp decline in the inflation rate. The food- inflation rate has declined from a high of 10.87 per cent in October 2024 to a negative 2.28 per cent. The decline has been partly driven by a high base. Economists expect this pattern to continue in the coming months. The headline rate, meanwhile, has declined from 6.21 per cent in October 2024 to 1.54 per cent in September 2025. The MPC had considered such a possibility in its last meeting and reduced the inflation projection for the current year to 2.6 per cent as against 3.7 per cent in June. It also raised the growth projection to 6.8 per cent from the earlier forecast of 6.5 per cent — mainly due to higher than expected growth in the first quarter of the current financial year —  but expects growth to slow in the second half. Since monetary policy works with a lag and needs to be forward-looking, it is always important to see how the RBI expects inflation and growth to evolve over the next several quarters. While the inflation rate has come down significantly over the past several months, as things stand, the RBI expects the trend to reverse in the coming quarters. 

As the RBI’s latest Monetary Policy Report showed, the central bank expects the inflation rate to average 4.5 per cent next financial year, with the rate increasing to 5.1 per cent in the third quarter. It would be hard for the MPC to justify rate cuts with this kind of projection. Some economists argue that the neutral rate — the real policy rate that is neither expansionary nor contractionary — has declined to about 1 per cent, compared to earlier estimates of 1.4-1.9 per cent. Even assuming this is the case, it would be difficult to cut the policy rate from 5.5 per cent with the average projected inflation rate of 4.5 per cent in 2026-27. The policy space might open up if the projections for next financial year get revised considerably. Otherwise, if the MPC cuts the repo rate, it will not be durable to have the desired impact on the economy. In terms of growth, the RBI’s base case for 2026-27 is 6.6 per cent, which is not considerably different from the current year’s projection. 

There are two other aspects. First, the goods and services tax rates were reduced recently, which, along with income-tax relief, is expected to boost demand. The level and extent will need to be carefully mapped. Second, the MPC members in the last meeting noted that the cumulative 100 basis-point rate cut was still working through the system. More clarity on these aspects should emerge by the December MPC meeting. Thus, several factors would go into forming the MPC's view. The most crucial, of course, will be the possible changes in the 2026-27 inflation projection.