MPC should wait for more clarity on inflation before deciding on rate cuts

With GST cuts fuelling festive demand and growth holding strong, the RBI's MPC is likely to stay cautious on rate cuts as it weighs inflation risks and uncertain global trade headwinds

The meeting of the six-member Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) this week coincides with the festival season. Initial reports tracking online transactions suggest a significant jump in demand. Although a clear position will emerge in the coming weeks as companies report their monthly and quarterly numbers, the rationalisation of goods and services tax (GST) is likely to have influenced households’ buying decisions. The GST system has been adjusted, mainly to a two-rate structure, which has reduced tax on a majority of items. It will be interesting to see the extent to which this influences the MPC’s gross domestic product (GDP) growth projection for this financial year. The projection is likely to be revised upwards, also because first-quarter (April-June) GDP growth came at 7.8 per cent, compared to the MPC’s projection of 6.5 per cent. On the downside, projections need to factor in tariffs by the United States (US), although, to be fair, it is not clear for how long the higher tariffs will last. Indian negotiators are working with their US counterparts to arrive at mutually acceptable terms of trade. 

Overall, growth is unlikely to be a big concern for the MPC at the moment. On inflation, the committee, in its last meeting in August, projected the rate to average 3.1 per cent this financial year, which some analysts argue is an overestimate. The GST reduction is likely to reduce the inflation rate in the near term, though the MPC may choose to look through or ignore this one-time adjustment. Even though inflation outcomes in recent months have been favourable, monetary policy needs to be forward-looking. In this regard, the August meeting of the MPC projected an inflation rate of 4.4 per cent for the last quarter this financial year, increasing further to 4.9 per cent in the first quarter of 2026-27. 

If these projections hold, there is no scope for a rate cut. Thus, the MPC’s decision will be influenced by its estimate for these periods and beyond. The space for further rate cuts will open up only if the retail-inflation projections for next financial year shift significantly below the target of 4 per cent. While the food-inflation rate is likely to remain comfortable owing to the good monsoon this year, which also supports winter crops, the core-inflation rate has been running above the 4 per cent target. Although some analysts have projected softer inflation outcomes in the coming quarters, the MPC’s decision will depend on its own revised projections. 

The MPC would also likely consider at least two other aspects. First, there has been a fiscal push to demand — initially through income-tax relief and now through a reduction in GST rates. So, should the RBI stay put at this stage, or support demand with a cut in the policy rate? Second, will a rate cut boost demand at this stage? It is worth noting that the transmission of policy rate cuts into market interest rates has not been particularly smooth. The yield on 10-year government bonds has increased by about 25 basis points since the 50 basis-point policy rate cut on June 6. Thus, another cut of 25 basis points at this stage will not help a great deal. Therefore, against the given broader macroeconomic backdrop, it would make sense for the MPC to maintain the status quo and see how growth, inflation, and fiscal positions pan out over the next couple of months.