RBI’s Growth Forecast May Face A Downgrade, But Stable Inflation Offers Relief

The Reserve Bank of India’s Monetary Policy Committee begins its three-day meeting today. While questions remain over whether the policy repo rate will be lowered after two years of being left unchanged at 6.50%, there is little doubt about what the central bank will do with its key macroeconomic forecasts.

First, inflation: back in December, the projection for 2024-25 was raised by 30 basis points to 4.8%, with the figure for the third quarter receiving a sharp upward revision of 90 basis points. However, headline retail inflation was seen receding to the medium-term target of 4.0% by the second quarter of 2025-26. There is little to suggest from the price developments over the last couple of months that the outlook has deteriorated further, with CPI inflation dropping nearly a full percentage point to 5.22% in December from 6.21% in October.

The trajectory of some factors that influence inflation has been markedly different than what the RBI expected a few months ago. Chief among them is the exchange rate. In October, the RBI’s forecasts assumed the rupee would trade at 83.5 per US dollar in the second half of 2024-25. Instead, the rupee has hurtled past the 87-per-dollar mark this week. On the whole, though, inflation developments have been broadly favourable, and cooling vegetable prices should more than nullify the threat of imported inflation.

The second key number to watch out for on Friday will be the growth forecast. In December, the RBI factored in the big shock that was the 5.4% GDP growth print for the second quarter of 2024-25, downgrading its projection for the full year by 60 basis points to 6.6%. However, matters have seemingly worsened since then, with the statistics ministry’s first advance estimate of GDP growth for 2024-25 predicting that the growth will fall to a four-year low of 6.4% this year.

Now that the statistics ministry has spoken--yes, the GDP data will quite definitely undergo several more revisions--the RBI has little choice but to take the number at face value. What will be interesting is what the central bank does to its growth forecast for 2025-26.

The October Monetary Policy Report had projected a growth rate of 7.1% in 2025-26, with the quarterly numbers being 7.3%, 7.2%, 7.0%, and 7.0%. By December, growth in the first half of the next financial year was already lowered somewhat to 6.9% in April-June and 7.3% in July-September, with the minor upward revision of 10 basis points in the second quarter likely driven by a low base effect after the disastrous 5.4% growth rate clocked in the corresponding period of 2024-25.

Mid-December, the RBI’s monthly State of the Economy article showed that internal models of the central bank’s staff indicated GDP growth in 2025-26 was seen at 6.7%. The Economic Survey tabled in Parliament last week was even more pessimistic, indicating the Indian economy may grow in the range of 6.3-6.8% next year.

All indications, then, are that Friday will see the RBI retain its inflation forecast for the current financial year and for the first half of the next while tempering growth expectations. Ideally, this should be a recipe for an interest rate cut. But the concoction is not pure. 

Frist, the liquidity deficit in the banking system remains large and may not allow for the benefits of a reduced policy rate to be transmitted to borrowers. Second, the Union Budget has already imparted a sizeable demand push in the form of personal income tax rate cuts that will set the central government back by ₹1 trillion. Third, as mentioned earlier, is the threat of imported inflation that could become even larger depending on how erratic US trade policy gets. 

Finally, parts of the MPC itself are an unknown, with Governor Sanjay Malhotra and Deputy Governor M. Rajeshwar Rao set to take part in a review of domestic monetary policy for the first time. Even though it may be easy to predict how the RBI’s macroeconomic forecasts could change, it is far trickier to put a finger on how the six-member committee might vote on the interest rate.