When monetary flexibility meets growth uncertainty
The Reserve Bank of India’s October policy was a close call with growing clamour for easing of policy rates as India’s growth outlook has become more uncertain.
India’s real GDP growth outlook is caught between the tailwinds of the GST rate cuts and the headwinds of the US’s steep tariffs. Meanwhile, inflation remains subdued, led by deceleration in food inflation.
Despite the heightened uncertainty on India’s growth, RBI on Wednesday maintained status quo on policy rates and retained its neutral stance. The key change was in the messaging, with RBI governor Sanjay Malhotra indicating space to ease policy rates due to significant moderation in inflation.
This policy flexibility is in sharp contrast to the June policy, when RBI had indicated that the bar for further rate cuts was high. The change in assessment is driven by a more benign inflation outlook due to a favourable monsoon. The GST rate cuts also added to the comfort on headline inflation.
The inflation factor
RBI lowered its inflation estimate for 2025-26 to 2.6% from 3.1%, and for the first quarter of FY27 to 4.5% from 4.9%.
That said, its outlook on inflation’s quarterly trajectory wasn’t as benign, with inflation expected to climb to 5.1% in the third quarter of FY27. The central bank projected full-year FY27 inflation at 4.5%.
This implies that the current real policy rate is 1%, which is below RBI’s estimate of neutral real rates (1.4% to 1.9%). Neutral real rates are difficult to estimate, but given the heightened trade-related volatility, it’s likely to be closer to 1%.
In other words, RBI’s inflation outlook indicates that the space to ease rates may not be much.
US tariffs weigh on growth
Another factor behind RBI indicating space to ease policy rates is the risks to India’s economic growth.
At first glance, RBI’s assessment on India’s growth seems positive—the central bank raised its FY26 GDP growth estimate to 6.8% from 6.5%. But this was mainly due to India’s 7.8% GDP growth in the April-June first quarter, which blew past market expectations.
But RBI lowered its GDP growth estimate for the second half of FY26 by 10 basis points to 6.3%, indicating that the US’s 50% tariffs on Indian merchandise exports would outweigh the positive impact of GST cuts on growth.
Neutral or accommodative?
RBI’s discussion on its monetary policy stance provided deeper insight into the internal deliberations among monetary policy members and concerns on growth outlook.
Two external members—Nagesh Kumar and Ram Singh—wanted the stance to be changed to accommodative from neutral. Under an accommodative stance, rate hikes are off the table.
This divergence of views indicates that the minutes of the October policy could be more dovish than the governor’s statement.
So why didn’t RBI cut its policy rate?
This brings us to the next logical question. If RBI sees space to ease policy and there is uncertainty on growth outlook, why not ease now? The simple answer is space to ease rates doesn’t translate into need to ease rates.
The real rates analysis shows that current policy settings are not hindering India’s growth recovery. Also, domestic growth drivers remain resilient in RBI’s assessment, with rural demand expected to improve and urban demand to get support from fiscal policy (income tax cut and GST cuts).
Eyes on December policy
The risk to growth is mainly external due to the US’s adverse tariffs. Negotiations between India and the US for a bilateral trade agreement are ongoing, and if successful could result in the tariffs being reduced to 25%.
Another factor behind the pause is that monetary policy easing is being augmented by fiscal stimulus in the form of the GST rate cuts. RBI wants to see the impact of these measures on consumption in the coming months.
Hence, for a rate cut to happen, growth risks would need to materialize. This could be in the form of India and the US failing to reach a trade deal, or the spread of trade tensions from merchandise to software services. Or if domestic consumption doesn’t pick up despite festive season sales and the GST cuts.
Clarity on these growth risks will be available by the December policy.
Gaura Sen Gupta is chief economist, IDFC First Bank
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