RBI sees strong economic momentum, inflation relief; warns of trade risks

The Reserve Bank of India (RBI), in its monthly bulletin on Wednesday, said in India, economic momentum is poised to be sustained, while strong rural demand is expected to receive a further fillip from the robust performance of the agriculture sector. On urban demand, too, the central bank says there is a possibility of a recovery, with a decline in inflation as well as a boost to disposable incomes from the sizeable income tax relief announced in the Union Budget 2025-26.

The Budget measures are expected to fuel four engines of growth – agriculture, MSMEs, investment and exports, which will provide a boost to the medium-term growth prospects of the Indian economy. The RBI says the Union Budget "prudently" balances fiscal consolidation and growth objectives by continued focus on capex alongside measures to support consumption while providing a clear roadmap for debt consolidation.

Domestic demand is also expected to benefit from the repo rate cut by the MPC in its meeting on February 7, 2025. "Robust kharif production and better rabi sowing, coupled with higher reservoir levels and seasonal winter correction in vegetable prices, augur well for food inflation going forward. While core inflation remains muted, uncertainty in global financial markets, volatility in energy prices and adverse weather events present upside risks to the inflation trajectory," says the RBI.

Amid the reciprocal tariff threat from the Trump-led US administration, the RBI says the near-term global outlook is being shaped by trade-related policies of major economies amid the slowing pace of disinflation. "There are also concerns that these policies could stoke inflation, engender tighter financial conditions, and heighten market turbulence."

The RBI believes a strong dollar, driven by U.S. economic resilience and trade policy pivots, could exacerbate capital outflows from emerging economies, push risk premiums higher, and intensify external vulnerabilities. "The “last mile” of disinflation may become more challenging in such an environment, potentially requiring central banks to recalibrate policies."

Overall, the RBI says the global economy continues to grow at a steady but moderate pace, with a divergent outlook across countries amid rapidly evolving political and technological landscapes. Financial markets also remain on edge about the slowing pace of disinflation and the potential impact of tariffs. Emerging market economies (EMEs) are witnessing selling pressures from foreign portfolio investors (FPIs) and currency depreciation engendered by a strong US dollar.

The RBI says in India, high-frequency indicators point towards a sequential pick-up in the momentum of economic activity during H2:2024-25, which is likely to sustain moving forward. "The Union Budget 2025-26 prudently balances fiscal consolidation and growth objectives by continued focus on capex alongside measures to boost household incomes and consumption. Retail inflation moderated to a five-month low in January, mainly due to a sharp decline in vegetable prices," it adds.

Notably, the headline CPI inflation moderated to a five-month low of 4.3% in January 2025 as food prices, especially those of vegetables, recorded a sharp decline driven by the arrival of winter crops in the market. Core (CPI excluding food and fuel) inflation exhibited a gradual increase since May 2024 but remains below 4%.

In the bimonthly monetary policy meeting of February 2025, the Monetary Policy Committee (MPC) of the Reserve Bank reduced the policy repo rate by 25 bps to 6.25 per cent as growth-inflation dynamics opened up policy space to support growth while remaining focussed on aligning inflation with the target. The MPC noted that excessive volatility in global financial markets and continued uncertainties about global trade policies, coupled with adverse weather events, pose risks to the growth and inflation outlook. Accordingly, it voted to continue with a "neutral stance", which provides the flexibility to respond to evolving macro conditions.