Will RBI Cut Repo Rate After Two Years as Inflation Eases, or Maintain a Hawkish Stance?

With December numbers indicating a cooldown in retail inflation, the Reserve Bank of India (RBI) faces a lingering question that has been troubling India's economy and fiscal policymakers for some time: will growth finally take center stage in its next Monetary Policy Committee (MPC) meeting, scheduled for February 5 to February 7? India is heading towards 'Viksit Bharat' or developed nation status by 2047. But the realisation of this dream demands over 8% growth.

Inflation in India has driven RBI's most of the policy actions recently. This focus stems mainly from a significant rise in food inflation, which has exceeded 9% in recent months, creating substantial pressure on household budgets.

Stance on Inflation : Govt vs RBI

Before the December MPC meeting last year, finance minister Nirmala Sitharaman, emphasised a rate cut to stimulate economic growth. Commerce and industry minister Piyush Goyal even said that considering food prices while deciding on interest rate structure was a “flawed theory”.

"Everyone is entitled to their views but as I look at it, growth is impacted by a multiplicity of factors, not just one factor of repo rate," said Shaktikanta Das, then RBI governor, during his swansong media conference last month.

He also flagged restoring the inflation-growth balance as the most important task ahead of the RBI.

"Inflation raises government expenditure on subsidies, aggravating fiscal deficits and increasing interest rates. Therefore, achieving a delicate balance between growth and inflation is vital," said Ajit Mishra, senior vice president of research at Religare Broking.

"While economic growth has decelerated, this is not solely attributed to higher interest rates; reduced capital expenditure by both the government and private sector also plays a role. Since growth and inflation are interconnected and driven by cyclical factors, the RBI has adjusted its priorities accordingly," Mishra added.

By shifting from a "withdrawal of accommodation" to a "neutral" stance and maintaining the repo rate at 6.5%, the RBI has created room for flexibility in addressing changing economic conditions.

The finance ministry highlighted in its monthly economic review for November last year that the combination of monetary policy stance and macro prudential measures by the central bank may have contributed to the demand slowdown in the first quarter of the FY25. It was the first official statement from the ministry that highlighted its divergent views with the RBI regarding growth and inflation.

Meanwhile, India's gross domestic product (GDP) growth for FY25 also projected to be at 6.4%, lower than both the growth estimate of the RBI and the government.

Rupee Depreciation

While inflation is comparatively lower, a new devil has arisen on the horizon—the rupee depreciation. Domestic currency hit an all time low crossing Rs 86 per dollar mark in January.

Read More | Rupee Hits Record Low at 86: Will RBI Focus on Growth or Address Depreciation?

According to a Bloomberg report, RBI governor Sanjay Malhotra appears prepared to let the rupee move more freely, in line with regional currencies, but will still step in to manage excessive fluctuations in the foreign exchange market.

Navigating Global Shifts

Donald Trump's return to the White House has heightened global economic anxiety, with significant attention on potential policy shifts in the United States. The rupee has fallen about 3% against the dollar since Trump's victory in November last year.

This raises another important question: will central bank factor these developments into their decision-making processes?

Mishra warns that protectionist policies could disrupt India’s export sectors and lead to forex volatility, a weaker rupee, and higher borrowing costs. However, he sees an opportunity for India to reduce reliance on China and emerge as a manufacturing hub, with RBI likely focusing on liquidity and credit measures to address these challenges.

Independent economist Prithviraj Srinivas points that while currency devaluation could be an alternate to maintain external competitiveness, it could also turn unfavourable and hurt domestic consumption as well as infrastructure investment aspirations.

Read More | Why Weak Rupee May Fail To Give Competitive Advantage To Indian Exporters

Aditi Gupta, an economist at Bank of Baroda, feels that global developments, particularly in the US are likely to have only a limited direct impact on India but it could lead to higher volatility in the financial markets in the near term, which could have some spillover impact on the Indian economy.

"We expect the RBI to adopt a cautious approach in the next policy meeting as it awaits more clarity on these developments," says Gupta.

Will RBI Push the Accelerator Pedal?

Srinivas says that it is important for the RBI as well as the government to reflect on whether the country currently has the institutional and administrative framework that could enable over 8% growth before pressing the accelerator pedal.

"Stoking growth towards 8% desired level using macro-policy while not making sufficient progress on institutional reforms would be akin to delivering a short-lived sugar high which will not sustainably address weak real income growth concerns," he adds further.

He also highlighted that weak real income growth among certain income strata has led to stagnation in sales, resulting the recent growth moderation.

“If anything, one might ask whether policymakers could have done more—or acted earlier—to protect the real incomes of Indian households and if we let the exuberance run too long," Srinivas notes, acknowledging that weather volatility and geopolitical tensions have contributed to price instability. He questions whether India is sufficiently shielded from these recurring.

Mishra notes that it is important for RBI to craft policies that ensure sustainable economic growth without jeopardising price stability, as both are crucial for India's long-term economic health.

"There is a delicate balance between growth and inflation. Inflation affects growth and vice versa. It does not seem judicious for the RBI to forgo one for the other," Gupta adds. She doesn't foresee an interest rate cut in February, as emerging inflation risks may prompt alternative measures to boost growth, including easing liquidity in the banking sector.

RBI MPC reduced the cash reserve ratio (CRR) by 50 basis points in its last meeting, injecting approximately Rs 1.16 lakh crore into the banking system to enhance liquidity.

Can Growth-Oriented Policy be Risky?

Economists caution that prioritising growth at the expense of inflation could have unintended consequences.

"High inflation erodes purchasing power, particularly among lower-income groups, adversely affecting living standards and weakening consumer demand in India's consumption-driven economy," Mishra noted.

Echoing the same sentiment, Srinivas emphasised the importance of inflation aligning with the anticipated path toward 4% by mid-2025. He warned that failure to achieve this target could lead to a further erosion of external competitiveness and a continued decline in real income growth—factors.

As economists debate the ideal path forward, all eyes will be on the RBI’s decision in February—will the central bank prioritise immediate economic stimulus, or take a wait-and-see approach until clearer headwinds emerge? A lot is piling on the decimal, with anticipation running high over whether the RBI will finally cut rates after two years.