RBI may pause rate cuts in August

The recent US announcement to impose a 25% tariff plus penalties on India’s exports has added another layer of uncertainty to the economic outlook. This has reignited debate around further monetary easing by the Reserve Bank of India (RBI). But despite the favourable inflation data and mixed growth trend, the central bank may opt to wait before acting again.

Healthy food

Headline Consumer Price Index (CPI)-based inflation dropped to 2.1% year-on-year in June, the lowest since early 2019. For the first half of 2025 (1HCY25), CPI averaged 3.2%, well below the RBI’s 4% target.

Food inflation has been the key driver of this disinflation. In June, food prices contracted by 1.1% on-year, led by a 19% drop in vegetable prices, and falling costs in pulses and protein-rich items, while prices of cereals moderated.

This trend reflects not just a favourable base effect but also strong domestic supply conditions, aided by a robust harvest season and an early, above-normal monsoon.

Stable core

Core inflation (non-food, non-fuel) edged up to 4.5% in June, from 3.4% in 2024, while “core-core” inflation (excluding volatile items like gold, fuel, and silver) rose to 3.6%. While this marks a modest increase, underlying momentum remains subdued. Monthly sequential growth is holding steady at 0.3%, showing no signs of overheating. Notably, core-core inflation has remained sub 4% for the last 20 months. Even as core services show a pick-up led by some rise in education and communication segments (administered telecom tariff hikes), core goods inflation is stable at sub 3% level. These dynamics suggest that inflation is adjusting upwards mildly from previous lows, rather than accelerating.

Supportive trends

The recent trend in wholesale price index (WPI)-based inflation reinforces the debate of lower inflation. In June, it entered mild deflation, contracting by 0.1% on-year. Again, food prices led to the decline even as core WPI remained at a modest 1%, indicating limited cost-push pressure in the pipeline.

Global price indicators are equally benign. On average in CYTD25, the CRB commodity index has risen by 3.2% on-year, while Brent crude is down 15.1% on-year. This additionally reinforces no build-up of inflationary pressure from upstream and external forces.

A temporary trough

Looking ahead, we expect inflation to average 2.5% in 2HCY25, with July’s reading likely falling below 2%. However, this disinflation phase may be temporary. As the favourable base fades and food prices stabilize, inflation is projected to rise gradually back to 4% by early 2026.

Importantly, inflation expectations remain anchored. The RBI’s household inflation expectation survey shows declining expectations for both three-month and one-year-ahead horizons. This should help contain second-round effects even as headline CPI normalizes.

The RBI’s dilemma

With inflation under control, expectations for a cut in August have risen. Further, adding to expectations of a cut are mixed trends in growth data and the recent US announcement of higher tariffs (25% plus penalties) on India’s exports. While we expect the rate easing cycle to end with a final 25 basis point cut in Q4, as growth will likely be weaker than the RBI’s estimates, we believe that the central bank will pause in August and wait for more data before acting again.

We premise our view on three reasons: (a) real interest rates are already in the neutral zone (1.4%-1.9%), suggesting policy is appropriately calibrated; (b) even as near-term inflation is likely to undershoot the RBI’s estimate, we believe one-year-ahead inflation expectations will likely be unchanged, which is important as monetary policy works with lags; and (c) while inflation has surprised on the downside, growth data is still evolving, and the RBI may want more clarity on the recovery’s durability given the front loaded policy action in June. In this context, both trends in high-frequency domestic demand with the upcoming festive season and clarity on US-India trade negotiations will be important to track.

Medium-term strength

India’s disinflation success is not just cyclical—it’s structural. Since the adoption of inflation targeting in 2016, average inflation has fallen to 5%, down from 8.6% in the preceding decade.This framework, combined with a prudent fiscal policy and a better mix of growth drivers, has reduced volatility and increased credibility.

The government’s focus on capital expenditure, especially in infrastructure, has improved supply-side efficiency. These trends, along with a favourable Total Factor Productivity trajectory and falling Incremental Capital Output Ratio (ICOR), are reducing long-term inflationary bottlenecks.

Additionally, the evolving macro framework has led to reduced rate volatility, with interest rate cycles becoming more predictable and decoupling from global policy paths. This stability in the cost of capital offers greater certainty to businesses and investors, which is valuable in today’s volatile global environment.

Views are personal.

The author is the chief India economist at Morgan Stanley.