Global Uncertainties and India’s Monetary Policy
The Reserve Bank of India’s (RBI’s) monetary policy decision has been complicated by escalating global uncertainties. Despite muted inflation, the central bank faces challenges due to a dampened growth outlook caused by US tariffs. The uncertainty surrounding US trade policy and the likelihood of a trade deal further contributes to the complexity of the situation. India’s domestic demand indicators have been improving, and policy support in the form of GST rate cuts is expected to boost domestic demand.
Impact of US Tariffs on India’s Economy
A 50% duty imposed by the US has made India one of the highest tariffed nations. Although exports to the US constitute only around 2% of India’s GDP, the high tariff will significantly impact India’s exports. The annual impact of the 50% tariff could be as high as 0.8-1% of GDP. Additionally, the recent announcement by the US of higher H-1B visa fees and the proposed HIRE Act, which seeks to curb outsourcing by US companies, could negatively affect services exports.
Current Account Deficit and Capital Flows
Despite the challenges posed by exports, India’s current account deficit to GDP is expected to remain comfortable at around 0.9% in the base case scenario. Even with higher risks, it may only worsen to around 1.3% in FY26. This is supported by healthy services exports, remittances, and benign global crude oil prices. However, capital flows have been adversely impacted by persistent FII outflows from the equity market and feeble net FDI flows, and are likely to remain volatile amid global uncertainties. India’s high forex reserves of around $700 billion provide a measure of comfort.
Government Measures to Boost Domestic Demand
The government is taking measures to boost domestic demand, including the recent GST rationalization, which should help bolster domestic consumption and reduce inflation. The government may also consider targeted support to affected export sectors like textiles, ready-made garments, gems & jewellery, and seafood. Overall, India’s GDP growth is expected to be around 6.5% in FY26, assuming the additional punitive tariff of 25% will be removed soon. However, GDP growth could fall closer to 6% if the 50% tariff stays longer.
Inflation Outlook
CPI-based inflation is under control, with the average inflation for the last three months at 1.9%. The sharp fall in inflation is due to moderation in food prices and the statistical impact of a high base from last year. CPI inflation is likely to average a benign 2.7% in FY26, after incorporating the GST rate cut impact. However, next year, inflation is expected to rise again as the base effect reverses, and the inflationary outlook will depend on the monsoon situation. CPI inflation is expected to breach the 4% level in Q4 FY26 and average around 4.5% in FY27, assuming a normal monsoon.
Monetary Policy and Liquidity
The system liquidity was ample in the last few months, with the call rate hovering below the policy repo rate. The RBI may continue to intervene as required to maintain ample liquidity in the system and ensure smooth transmission of the rate cuts so far. Given that the policy rate has already been cut by 100 bps and the CRR by a huge 1% in the current year, the central bank may decide to wait and get further clarity on US trade policy and its impact on the Indian economy.
Conclusion
In conclusion, the RBI’s monetary policy decision is complicated by global uncertainties and a dampened growth outlook. While the government is taking measures to boost domestic demand, the central bank may adopt a wait-and-watch policy to get further clarity on the growth outlook. With GDP growth estimated at around 6.5% for FY26, the central bank may not need further rate cuts, but if the high tariff scenario persists and the growth outlook worsens, the central bank could consider a rate cut later during the year.
