There is no denying the sense of relief over February’s retail inflation coming in at a seven-month low at 3.61 per cent, led by benign trends in food prices. Analysts have pegged the March inflation reading at below 4 per cent levels as well, setting the stage for another rate cut when the Monetary Policy Committee convenes next month. If this projection turns out right, Q4 inflation will undershoot the Reserve Bank of India’s projection of 4.4 per cent by about 50 basis points, since January’s inflation rate was 4.26 per cent. With RBI having projected a modest 6.7 per cent growth in FY26 (and 4.2 per cent inflation, which is at the lower end of its acceptable band), a 25 basis point cut, following up on the MPC’s February move, seems in order. This will boost consumption as well as private investment.
With core inflation pegged at 4-4.5 per cent in FY26, according to analysts, a modest rate reduction cycle looks possible. There is, however, a real possibility of Trump’s tariffs adding to core inflation. SBI Research points out that the share of imported inflation in overall inflation has risen sharply since last June. Meanwhile, there is also the old question of whether the MPC should ‘look through’ food inflation, in case it rears its head in the event of an early, harsh summer. Since mid-2023, food inflation has emerged as the key driver of overall price increase, while core inflation has been declining (Economic Survey 2024-25). Given this context, the RBI waited too long to cut the repo rate, held at 6.5 per cent since February 2023, even as a consumption and investment slowdown was building up. The divergence between food (higher) and headline inflation (lower) has been pronounced in the second and third quarter of this fiscal, but has converged since then. Headline inflation has been slightly lower in FY25 than FY24.
It is significant, despite the base effect, that food inflation has dipped from 10.9 per cent in October 2024 (headline inflation of 6.2 per cent) to 3.75 per cent in February, almost converging with the headline rate. After all, food inflation has been at above 6 per cent in 57 per cent of the months between June 2020 and June 2024, thanks to climate-change related developments, as an RBI paper points out. The RBI should indeed not repeat the past error of being wholly guided by food prices. That said, the future trajectory of rate cuts would also depend on core inflation, besides any surge in financial and geo-political headwinds.
It is about time that the RBI arrives at a position on how it should respond to headline inflation if it is driven by food products. The onus of controlling food prices should rest with the government, which can address supply bottlenecks. Meanwhile, the prospect of the dollar losing some steam with signs of the US economy heading for some trouble, could widen the window for cutting rates.
