 "inflation, fmcg")
India’s inflation has entered a new phase. After six years of battling above-target inflation, through the pandemic, wars and food price shocks, headline inflation finally appears set to sustainably undershoot the Reserve Bank of India’s (RBI’s) midpoint target of 4 per cent in 2025-26. If this disinflationary trajectory holds, the scope for monetary policy to support growth would be much greater than most expect.
Why sub-4 per cent inflation is here to stay
While a sustained period of sub-4 per cent inflation sounds ambitious, we see multiple favourable demand- and supply-side factors.
First, the starting point is benign. Headline inflation has dropped below 4 per cent, partly due to vegetable prices; but even excluding these, Consumer Price Index (CPI) inflation has averaged a low 3.6 per cent over the last year.
Underlying inflation remains benign too. Our measure of 20 per cent trimmed mean CPI inflation, which excludes outliers with the highest and lowest inflation rates, fell below 4 per cent back in January 2024, and was just 3.3 per cent this April. The RBI’s measure of core inflation has drifted above 4 per cent, but this was mainly due to higher gold prices. Excluding commodities from the core basket, the three-month seasonally adjusted annualised rate stood at just 3.5 per cent.
Second, food inflation appears likely to fall further. Pulses typically follow a cobweb cycle, where higher prices incentivise more sowing, which leads to increased supply and lower prices. Thanks to higher production and increased imports, the prices of pulses have already begun to decline and are likely to fall further, in our view.
Robust domestic production and subdued demand have led to deflation in spices. A larger rabi harvest, comfortable reservoir levels and a favourable monsoon this year should also moderate cereal price inflation further. India’s inflation cycles are driven by food prices, so this is important.
Third, input costs are moderating. For agriculture, fertiliser, diesel, and fodder price inflation have fallen and rural agricultural wage growth remains low. For manufacturing, energy and industrial metal prices have moderated, lowering commodity cost inflation. For services, the moderation in salary and wage expenses of listed companies — a proxy for urban wages — is indicative of lower input costs.
Fourth, China is a source of disinflation. Even with the recent United States-China truce, US tariffs on Chinese imports are much higher than US tariffs on India. India’s imports from China picked up in March-April by a sharp 26 per cent year-on-year (y-o-y), suggesting rerouting and clearance of lower-priced Chinese products into India.
Fifth, there is slack in the economy. Moderating credit growth, weaker global demand, the impact of uncertainty on private capex and lags in policy transmission mean that the output gap is likely to remain slightly negative in FY26.
Sixth, the currency is not a major risk. The slowdown in US growth, asset reallocation away from the US, concerns over the US fiscal position, and the market view that exchange rates are being discussed as a part of trade negotiations in Northeast Asia, mean that the US dollar is likely to remain soft over coming months.
Inflation undershoot ahead
Aggregating these factors, we expect inflation to moderate from 3.2 per cent y-o-y in April to below 3 per cent for several months starting in May, with CPI inflation on average likely to undershoot the RBI’s midpoint target of 4 per cent by a significant margin in FY26.
The inflation drop is likely cyclical, but it should have other salutary effects as well. For example, lower food prices should moderate households’ inflation expectations even further.
Risks to watch
The key risks to this disinflation view are upside shocks due to geopolitical disruptions, weather vagaries and global financial market volatility, while a deeper global demand shock is a downside risk. The good news for India is that there is ample room to accommodate any of these upside risks.
What this means for monetary policy
India’s rate-cutting cycle will have to be calibrated against the backdrop of global risks. The external backdrop remains challenging, with tariff, trade and policy-induced uncertainty, but this very uncertainty strengthens the case for a proactive domestic policy stance. If external demand weakens, domestic levers must take on a greater role. Fortunately, disinflation in India will stand in stark contrast to the tariff-induced inflationary shock expected in the US, which should allow the RBI to decouple from the Federal Reserve.
The RBI has already delivered 50 basis points (bps) of cuts thus far and shifted its stance to “accommodative”, but it assumes average CPI inflation of 4 per cent in FY26. An even lower inflation rate would mean the scope for rate cuts is even greater than previously expected.
Past research from RBI staff estimates the neutral real rate in a range of 1.4-1.9 per cent. However, with growth below trend and inflation below target, real rates should be below neutral. The current policy easing cycle, therefore, is likely to be deep. We expect an additional 100 bps of rate cuts to a 5 per cent repo rate by the end of FY26, with risks skewed lower.
Low inflation has other positive spillovers
Low inflation is good for growth; it will boost real disposable incomes and support consumption. Lower input costs will improve corporate profit margins, while lower policy rates will reduce borrowing costs, supporting rate-sensitive sectors. Equally, balancing the interest of food consumers and producers (farmers) will be important for policymakers.
Low inflation should also reinforce macroeconomic stability. Monetary policy doing the heavy lifting will free the government to focus on fiscal consolidation, ensuring a lower fiscal risk premium. India’s overall macro fundamentals — low inflation, better relative growth, fiscal consolidation, low current account deficit, strong foreign exchange reserves — should provide enough space for monetary easing without stoking macroeconomic imbalances.
Room to absorb global shocks
India is entering a new phase of low inflation that provides the much-needed room for policy maneuverability to support domestic growth without compromising stability. In a world marked by heightened uncertainty and headwinds, low inflation is India’s quiet tailwind.
The author is chief economist (India and Asia ex-Japan) at Nomura
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
