With GDP growth at a high of 8.2 per cent in the second quarter and inflation at a low of 0.25 per cent in October, it is indeed a goldilocks situation for the Indian economy, as highlighted by the RBI governor. While the market was divided on the possibility of a rate cut, the MPC chose to use the window of opportunity provided by very low inflation to opt for a rate cut, while keeping the stance neutral. This was in line with our expectations. While the growth numbers are strong so far, there is heightened global uncertainty and a rate cut at this point would be supportive of growth. The RBI has also announced measures to inject liquidity in the system, to ensure smooth transition of policy rate cuts so far.
Inflation is on a downward trajectory, aided by deflation in the food category. Price pressures on other components also remain benign. Core inflation for the last three months is at an average of 4.4 per cent and excluding gold prices it is at a low of 2.8 per cent. For FY26, RBI has revised its average inflation projection downward by 60 bps to 2 per cent. With the low base of this year, we expect inflation to inch up and average 4 per cent in FY27.
So far, GDP growth has been supported by GST rate rationalisation, lower income tax burden, benign inflation, cuts in interest rate, healthy rural demand, strong capex by the Centre and front loading of exports to US. Moreover, there was also a statistical impact of low deflator and low base, that pushed up growth. However, we expect GDP growth to moderate in the coming quarters as the economy feels the pinch of higher US tariffs. The favourable statistical impact will also wear off in the second half. For the
full year, we still expect GDP growth to remain healthy at 7.5 per cent and at 7 per cent in FY27.
With high US reciprocal tariffs, India’s goods exports will feel the pinch. Non-petroleum goods exports to the US have contracted by a sharp 12 per cent in the last two months (Sep-Oct). While there has been some diversification to other markets, overall non-petroleum goods export growth has contracted by average 3.2 per cent in Sep-Oct as against growth of 7.4 per cent in Apr-Aug. However, with services exports likely to remain healthy and benign global crude oil prices, we project the current account deficit to remain comfortable at around 1 per cent of GDP in FY26. While the rupee has weakened sharply, we expect a trend reversal, given that on the REER basis the Indian rupee is undervalued by around 3 per cent. We expect the dollar index to continue the weakening trend in the medium term which should be supportive of rupee.
The RBI continues to focus on ensuring adequate liquidity in the system. And the governor has reiterated that they will ensure ample liquidity going forward to aid policy rate transmission.
With 125 bps of cuts, we feel this is the end of this rate cutting cycle. Given the repo rate of 5.25 per cent and inflation projected to average 4 per cent in FY27, the real rate of interest would be around 1.25 per cent, which is in the neutral range. Since we expect healthy GDP growth, there is no need for further rate cuts. However, the global situation is very uncertain and it’s better to keep policy ammunition ready to support growth as required. This becomes specifically critical at a time when scope of further fiscal stimulus is limited. Hence the RBI’s tone was dovish, hinting that there is scope of further rate cut if the growth outlook worsens.
The writer is chief economist, CareEdge Ratings
