INDIA: RBI likely to hold rates steady in April
Metodi Tzanov
Helping finance professionals understand what is going on in Emerging and Frontier Markets
In its latest meeting on February 8, the Reserve Bank of India's Monetary Policy Committee (MPC) implemented a significant shift by reducing the repo rate by 25 basis points to 6.25%. This move adjusted the standing deposit facility (SDF) to 6% and the marginal standing facility (MSF) to 6.5%. The unanimous decision underscored a strategic pivot towards bolstering economic growth. Notably, this rate cut occurred despite recent depreciation of the Indian Rupee (INR).
Inflationary Trends
Inflation eased to a five-month low in January 2025, reaching 4.3% y/y, driven by declining food prices. Although headline inflation remained above 5% for much of 2024, risks are still skewed upwards, particularly due to imported inflation exacerbated by the INR's depreciation. Government measures, such as releasing food reserves and imposing export restrictions, have helped mitigate short-term price spikes. However, global uncertainties-especially volatile crude oil prices and geopolitical tensions-continue to pose challenges. The RBI projects inflation at 4.2% for FY26, still above the medium-term target of 4%. Further, there is expectation that heatwaves across north India could impact winter harvest, which may stoke food inflation again.
Economic Performance
Economic activity showed signs of recovery in Q3 FY25, with private consumption improving and government expenditure increasing.India's GDP grew by 6.2% year-over-year in Q3-FY25, rebounding from a 5.4% increase in the previous quarter, driven by robust government spending and strong rural demand. This growth was supported by a good monsoon boosting agricultural output and resilient rural consumption, along with increased government capital expenditure post-elections. Gross Value Added (GVA) also matched the GDP growth rate at 6.2%, indicating a broad-based recovery. The National Statistical Office (NSO) has revised the annual GDP growth forecast for FY25 up to 6.5% from 6.4%, reflecting optimism for sustained growth. However, the dependency on government expenditure highlights ongoing challenges in sparking private sector investment.
Recent PMI data indicate choppy trends in Q4 FY25, though continued recovery is anticipated, as public expenditure picks up and consumer demand strengthens. The February PMI showed a slight easing in the manufacturing sector but strong growth in services. With growth showing weakness and limited fiscal stimulus in the FY26 budget, the RBI has taken on a more significant role in driving growth. Consequently, the RBI implemented the rate cut in February and will likely wait to assess its impact before considering further reductions in Q2. Despite macroeconomic challenges, India's banking sector remains stable. Credit growth averaged 16% in 2024, driven by strong demand in retail lending, services, and infrastructure financing.
External Sector
Foreign exchange reserves stood at USD 640.3bn as of Feb 21, providing a buffer against external shocks. However, the depreciating rupee remains a concern, having weakened to a record low of 87.6 per USD due to a strong dollar and resilient US economic performance in recent weeks. The RBI may adopt a cautious approach to rate cuts to avoid exacerbating external vulnerabilities. Further, the threat of the reciprocal tariffs, expected to be levied from April 2 will also weigh on the RBI's decision and on India's overall external sector.
Following the 25bps rate cut in February-the RBI's first policy easing move in 2025-the central bank is likely to hold rates in April. With the rupee under pressure and global uncertainties persisting, the RBI will pause to assess the impact of its policy shift. While inflation is expected to moderate further and economic growth remains a concern, the RBI may proceed with another rate cut subsequently in Q3.
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