Why low inflation raises hopes of more RBI rate cuts

India Today

18-05-2025

India's retail inflation, measured by the Consumer Price Index (CPI), fell to a near-six-year low of 3.16 per cent in April, compared to 3.34 per cent the previous month. The main driver was lower food inflation, at 1.8 per cent, due to decreased inflation for vegetables (-11 per cent). While lower inflation will leave more money in the hands of people for discretionary spending, it also gives the Reserve Bank of India (RBI) more room to further rate cuts, which, in effect, could lower the lending rates of banks for businesses and individuals.advertisementBoth in February and April this year, the RBI cut repo—that is the rate at which the central bank lends to commercial banks—by 25 basis points each, bringing the rates down to 6 per cent. The next meeting of the Monetary Policy Committee (MPC) of the RBI, which decides on interest rates, is slated for June.The Union government attributed the significant decline in retail inflation and food inflation in April to the fall in inflation of vegetables, pulses, fruits, meat and fish, personal care and effects, and cereals.According to a research report from the State Bank of India (SBI), penned by Soumya Kanti Ghosh, their group chief economic adviser, the sharp moderation in CPI inflation (last October, it was over the RBI's tolerance limit, at 6.2 per cent) bodes well for lowering the average CPI headline forecast for FY26 below 4 per cent. advertisementGhosh expects big cuts in interest rates. 'With multi-year low inflation in March and benign inflation expectations going forward, we expect rate cuts of 75 basis points (bps) in June and August (H1) and another 50 bps cut in H2, i.e. cumulative cuts of 125 bps going forward while 25 bps rate cut has already been initiated in Feb '25. However, we feel, jumbo cuts of 50 bps, could be more effective than secular 25 bps tranches spread over the horizon,' he said.In response to the 50-bps cut in the policy repo rate since February 2025, banks have reduced their repo-linked External Benchmark Lending Rates (EBLRs)—a mechanism used by banks to set interest rates for loans—by a similar magnitude. Whereas the Marginal Cost of Funds Based Lending Rate (MCLR) may get adjusted with some lag. MCLR is the benchmark interest rate used by banks in India to determine the minimum lending rate for various loans. It has a longer reset period and is referenced to the cost of funds.EBLR is directly tied to external benchmarks, such as the RBI repo rate, while MCLR is based on a bank's internal cost of funds. Larger transmission to deposit rates is expected in the coming quarters, the SBI report stated.advertisementSome analysts strike a more cautious note. A research note from the Bank of Baroda said that while 3.2 per cent is within the RBI's forecast of 3.6 per cent for Q1, the central bank will be cognisant of the fact that the number has come down mainly due to vegetables, which have a weight of 6 per cent in the index.Excluding this component keeps inflation at the target rate. 'It does look like this number may not trigger a rate cut given that there would be time to evaluate both the monsoon and tariff issues before taking a final call in August. Inflation would likely be low in May and June too due to the base effect,' the note said.Subscribe to India Today Magazine