Will a decrease in inflation result in a reduction of interest rates?
India's retail inflation has taken a significant dip, falling to around 3.75% in February 2025. This decline, primarily due to easing food price inflation and moderating fuel and light costs, marks the first decrease in retail inflation in six months [2].
Food inflation, which accounts for nearly half of the consumer price index (CPI) basket, has shown a notable decline. Lower prices in pulses, vegetables, fruits, cereals, and sugar products have contributed to this easing [2]. Fuel inflation has also shown moderation in this period.
The Reserve Bank of India (RBI) is likely to view this easing inflation as a sign of a more benign inflation outlook. This typically provides the RBI greater flexibility to focus on supporting economic growth rather than aggressively tightening policy [5][3]. Indeed, in subsequent months, inflation continued to fall below the RBI’s target range of 2%-6%, reaching even lower levels by mid-2025, which led the RBI Monetary Policy Committee to pause interest rate hikes after previously cutting rates by 100 basis points since February 2025.
The manufacturing sector reported encouraging growth figures in January 2025, with industrial growth standing at 5%. Basic metals, coke, refined petroleum products, and electrical equipment primarily contributed to this growth, while consumer durable goods followed capital goods in industrial growth, with a growth of 7.2% [1]. Capital goods led industrial growth in terms of use-based industry classification, with a growth of 7.8% in January 2025 [1].
However, consumer non-durable goods (FMCG) reported a 0.2% contraction in February 2025, suggesting lower day-to-day spending by people [1]. This contraction, coupled with the unpredictability of US President Donald Trump's policies, could potentially be an obstacle for a repo rate cut [1].
In light of the declining inflation and the broadly performing industry, the Reserve Bank of India may reduce the repo rate by 25 basis points in its monetary policy meeting, providing further support to the economy [4].
Sources:
- India's industrial output growth at 5% in January 2025
- India's retail inflation declines to 3.75% in February 2025
- RBI Monetary Policy Committee pauses interest rate hikes in 2025
- RBI likely to cut repo rate by 25 basis points in its monetary policy meeting
- India's retail inflation to remain subdued in 2025
In light of the declining inflation and the broadly performing economy, the Reserved Bank of India (RBI) may find the opportunity to support economic growth by reducing the repo rate, given the easing inflation and the easing of food inflation in the business sector, such as food products and consumer non-durable goods (FMCG). This potential reduction could occur in the RBI's monetary policy meeting, providing further stimulus.
