In a significant move to bolster economic momentum, the Reserve Bank of India's Monetary Policy Committee (MPC) has decided to cut the key interest rate by 25 basis points. This decision, announced following the committee's December meeting, comes against a backdrop of remarkably low inflation and robust real growth, providing the central bank with the necessary space to prioritize economic expansion.
A Peculiar Economic Backdrop for the Policy Decision
The MPC's meeting was held in an unusual economic environment characterized by three distinct trends. The Indian economy registered a strong growth of 8.2% in the second quarter of the year, with strength visible across agriculture, manufacturing, and services. However, nominal GDP growth for the first half of the year stood at 8.8%, which is notably lower than the 10.1% estimate used in the Union Budget.
On the price front, retail inflation has remained comfortably below the central bank's target since February 2025. The RBI's own projections estimate inflation will average just 2% for the year. Core inflation, excluding gold, was at 2.6% in October, indicating that the disinflationary trend is now widespread. Meanwhile, the rupee has faced pressure, breaching the 90 mark against the US dollar.
Rationale Behind the Rate Cut and Growth Outlook
The 25 basis point reduction marks a shift after the MPC held rates steady in its two previous meetings. The primary justification lies in the complete absence of imminent price pressures. Inflation forecasts for the coming quarters do not signal any major buildup, allowing the central bank to act.
On growth, however, the RBI has expressed caution. While high-frequency indicators suggest economic activity is sustained in the third quarter, the central bank noted emerging signs of weakness in a few leading indicators. External sector challenges, including a decline in goods exports in October, add to the downside risks. Consequently, the RBI has projected a growth softening to 7% in the third quarter and 6.5% in the fourth quarter.
The Path Forward: Monetary Policy Takes the Lead
With the government's fiscal space constrained following recent tax cuts and persistent external headwinds, the responsibility to support the economy now falls heavily on monetary policy. The RBI has also announced measures to ensure sufficient liquidity in the banking system, which is crucial for the effective transmission of the rate cut to the broader economy.
The future trajectory of policy will be predominantly determined by the performance of growth in the upcoming quarters. With inflation firmly under control, the central bank has clearly signaled its readiness to support growth, making the evolution of economic activity data the key variable to watch for future MPC decisions.
