India's economy outdoes expectations but rupee strain raises fresh risks

Despite trade-related uncertainties, the year 2025 is likely to end on a more favourable note for the Indian economy than most analysts had anticipated earlier in the year. Economic growth has been much stronger with benign inflation. The low consumer price index (CPI)-based inflation rate in recent months, along with a downward revision in projections for the coming quarters, enabled the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) to cut the policy repo rate by 25 basis points last week. Cumulatively, the MPC has reduced the policy rate by 125 basis points in the current cycle. The RBI also announced open-market operations worth ₹1 trillion and other measures to inject durable liquidity in the system, aiming to smooth the policy transmission. Given that recent inflation outcomes have been below expectations, prompting the RBI to once again revise its projections, the debate in financial markets now is whether the MPC will find space to further reduce the repo rate in the coming meetings.

 

The headline inflation reading for October, at 0.25 per cent, was the lowest in the current series. The MPC has revised the inflation projection for the current year to 2 per cent. The disinflation, though driven largely by food prices, has been broadbased. Excluding gold, for instance, the core inflation rate was at 2.6 per cent in October. The inflation rates for the first and second quarters of 2026-27 are now projected at 3.9 and 4 per cent, respectively. Assuming the projection holds, the real repo rate would be about 1.25 per cent, which is lower than the neutral rate — real policy rate that is neither expansionary nor contractionary — estimated by RBI economists last year. However, it is possible that the neutral rate itself might have changed.

 

Therefore, the MPC’s next move will depend on inflation outcomes in the coming months and the level of real policy rate it intends to maintain. In this regard, it is also worth noting that India will get a new CPI and national accounts series by February before the end of the current financial year. The anticipated decline in the weighting of food items is expected to make the inflation rate more stable and predictable. In terms of growth, after positive surprises in the first half of the year, the MPC has revised its gross domestic product (GDP) growth projection for the current year to 7.3 per cent — it expects growth to soften in the second half of the year. Growth rates in the first and second quarters of 2026-27 are projected at 6.7 and 6.8 per cent, respectively. Apart from the impact of the rate cut, which could be marginal, growth will depend on the outcome of India’s trade negotiations with the United States (US). Indian officials are hopeful that an agreement will be reached soon.

 

While the inflation and growth outcomes are favourable, the focus in the near term will be on the external position. The rupee crossed 90 against the dollar last week, having depreciated by over 5 per cent this year. Although it has become undervalued in real terms, the RBI has done well to let the rupee correct. Currency depreciation will help exporters contain the impact of the adverse trade environment to some extent. The rupee also needs to adjust to the capital outflows, largely from the equity markets. Foreign portfolio investors have sold shares worth about $17.7 billion so far this year. Outcomes on the currency in the near term will also depend on the conclusion of trade talks with the US. A delay can increase the pressure on the rupee.