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The Indian economy is navigating a complex landscape of decelerating growth and persistent inflation. The latest World Economic Outlook from the IMF paints a picture of global uncertainty, with growth remaining stagnant while inflation shows signs of decline, albeit slowly. This global backdrop further complicates the challenges facing the Reserve Bank of India (RBI) as it strives to manage the delicate balance between stimulating economic activity and controlling inflationary pressures. India's GDP growth has significantly slowed, falling to 6.4% in FY25, a considerable drop from the 8.2% recorded in FY24. This slowdown is primarily attributed to a sharper-than-expected deceleration in industrial activity, particularly in manufacturing, mining, and construction sectors. The Union Budget of February 1, 2025, aimed to revitalize the economy and boost investor confidence, but the effects have yet to fully materialize, highlighting the challenges of stimulating growth in a sluggish global environment.
Inflation, while showing a downward trend, remains a significant concern. While retail inflation is projected to fall to 4.5% in January 2025 and average 4% in FY26, the persistent stickiness of inflation, with four consecutive months above 5%, underscores the need for cautious monetary policy. The decrease in inflation is largely due to a sharp reduction in food prices, especially vegetables, offering some relief to consumers but not entirely mitigating the inflationary pressures. The RBI's previous actions of raising the repo rate by 250 basis points between May 2022 and February 2023 to combat inflation have had a significant impact on growth, exacerbating the trade-off between stable prices and economic expansion. This highlights the difficult choices policymakers face in managing the complex interplay between economic growth and inflation.
Given the current macroeconomic conditions, the RBI is strongly considering a 25 basis point reduction in the repo rate from 6.5% to 6.25% at its upcoming Monetary Policy Committee (MPC) meeting. This decision is driven by the combination of flagging GDP growth and persistently stubborn inflation, forcing the RBI to make a difficult choice between supporting economic growth and controlling prices. The injection of significant liquidity into the banking system, totaling Rs 1.5 lakh crore, further strengthens the case for a growth-supportive monetary policy. This liquidity infusion, combined with the income tax relief provided to taxpayers earning Rs 12 lakh or less, is intended to boost consumption and stimulate demand. However, the falling rupee poses a countervailing risk, potentially undermining the effectiveness of the rate cut. In essence, the RBI's policy decision hinges on navigating a delicate balancing act, attempting to foster economic growth while simultaneously taming inflation in a globally uncertain environment.
The potential rate cut is supported by a lower fiscal deficit and buoyant direct taxes, creating fiscal space for the RBI to act. This space, coupled with the evolving growth-inflation trade-off, suggests a strategic opportunity to implement monetary easing. The decision to lower interest rates reflects the RBI's attempt to seize the opportune moment, mirroring Shakespeare's metaphor of taking the current at the flood. Failure to act decisively could lead to stagnation and deepen existing economic challenges. The author, Dr. Manoranjan Sharma, Chief Economist at Infomerics Ratings, emphasizes the significance of proactive policy decisions to shape economic realities and achieve development goals. The decision underscores the complexities of macroeconomic management, requiring a skillful balancing of competing priorities to achieve sustainable economic growth and stability.
Source: Why the RBI may cut interest rates by 25 basis points on Friday