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The Indian economy finds itself at a crucial juncture, navigating a complex interplay of factors influencing growth and inflation. Finance Secretary Tuhin Kanta Pandey's recent call for a rate cut by the Reserve Bank of India (RBI) underscores the delicate balancing act the government is undertaking. Pandey's assertion that the time is ripe for a rate reduction is rooted in the observed waning of both domestic and international inflation. This aligns with a global trend of central banks easing monetary policies in response to easing inflationary pressures. The argument presented rests on the premise that the government has already demonstrated fiscal prudence, aiming to avoid inflationary pressures through controlled fiscal deficit management. Furthermore, proactive measures aimed at boosting consumption, such as income tax relief, have been implemented. The expectation now, according to Pandey, is for complementary action from the monetary policy side, namely a reduction in interest rates.
Several economists and market participants echo this sentiment, advocating for a reduction in the policy repo rate which has remained static at 6.5% since February 2023. The upcoming monetary policy committee meeting (February 5-7) is anticipated to be a pivotal moment, potentially marking the commencement of a rate cut cycle. HSBC Global Research, for example, predicts two 25 basis point cuts in the first half of 2025, reflecting a broader market expectation of such a move. However, this perspective is not universally shared. Some analysts remain cautious, suggesting that a rate cut cycle is unlikely unless there is a significant improvement in liquidity. This highlights the inherent complexities and uncertainties associated with making accurate economic predictions and the differing views among experts.
The debate surrounding the appropriate monetary policy response is further complicated by contrasting viewpoints within the government itself. A November report from the finance ministry had previously criticized the RBI's monetary policy actions, suggesting that the central bank's approach may have inadvertently contributed to a slowdown in economic demand. This discrepancy in perspective underscores the inherent challenges in coordinating fiscal and monetary policy effectively, particularly in the context of external uncertainties and differing interpretations of economic data.
The RBI's own projections for inflation provide a critical backdrop to the discussion. The central bank projects CPI inflation to fall to 4.8% in FY25 and 4.5% in FY26. These forecasts are partially anchored in expectations of softening food inflation, supported by a promising rabi harvest. The Economic Survey 2024-25 also notes a benign outlook for core inflation due to the softening of global energy and commodity prices. However, the survey acknowledges persistent risks stemming from geopolitical instability, including the Russia-Ukraine conflict and tensions in West Asia. This geopolitical uncertainty adds a layer of complexity, making the task of setting appropriate monetary policy even more challenging.
Finance Secretary Pandey acknowledges these geopolitical headwinds, noting their impact on export momentum and overall production. He views the growth rate projected by the Economic Survey (6.3-6.8% in FY26) as realistic in light of these external challenges. The income tax relief provided to the middle class, by allowing no tax up to Rs 12 lakh of annual income, is anticipated to stimulate the economy in several ways. Some individuals are likely to deposit the saved income in banks, increasing available liquidity. Others may choose to invest it in assets, furthering economic activity. The increased deposits could prove beneficial to banks, currently not experiencing a surplus of funds. Pandey’s remarks concerning the changes in basic customs duty (BCD) rate structure, implemented through the budget, suggest the adjustments aim to revitalize the economy rather than responding solely to external pressures, such as potential US tariff increases.
The budget's simplification of the customs duty rate structure, from seven slabs to a more streamlined system, is not expected to reduce overall tax incidence due to the counterbalancing effect of the agriculture infra cess. However, minor reductions in tax incidence are anticipated on specific items. The projected 2.1% growth in customs duty collections accounts for the changes made in BCD rates; however, the government underscores that customs revenue isn't a primary revenue source. Finally, addressing the OECD's Pillar 1 and Pillar GLoBE rules, the Finance Secretary emphasizes the need for careful evaluation of their potential impact. The US's recent withdrawal from these tax deals is seen as a significant factor, given the presence of major tech companies and significant investment flows originating from the United States. The government's decision to forgo immediate implementation of measures to comply with this two-pillar solution underscores a cautious and strategic approach.
Source: Time ripe for rate cut: Finance Secretary Tuhin Kanta Pandey