Tuesday's Talking Points
Lower CPI Inflation extends room for Rate Cuts!
What’s the Point?
CPI Inflation data released last week for February 2025 indicated a drop-in inflation to 3.6% YoY from 4.3% for Jan 2025. This was the first time in 6 months that inflation dropped below RBI’s median target of 4% inflation, and only the third time in FY25. Lower inflation this month was on account of moderation in the high food price inflation seen in past few months. Medium to long term drivers of inflation seem to be comfortably positioned, but near-term risks in terms of monsoon, uncertainty in global financial markets coupled with volatility in energy prices and adverse weather events presents upside risks to the inflation trajectory. With inflation being in a comfortable spot, the objective to mobilise economic growth in turbulent geopolitical environment could take precedence. Lower inflation and interest rates bode well for the overall economy both from a consumer and an investor standpoint. This also presents a potential investment opportunity in fixed income as an asset class, as yields could drift lower.
Numbers in Perspective
Source: CMIE, Bloomberg. WACR: Weighted Average Call Rate
Inflation for Q4 has been lower than RBI projections
RBI projections in the last monetary policy committee meeting kept Q4 inflation at 4.4%. With both Jan and Feb 2025 inflation being lower than 4.4%, there are downside risks to RBI projections in the near term. RBI’s has projected CPI inflation for FY2026 at 4.2%, with Q1 at 4.5%, Q2 at 4.0%, Q3 at 3.8%, and Q4 at 4.2%.
What led to inflation being lower?
The press release announcing the inflation numbers attributed the lower headline and food inflation to “decline in inflation of Vegetables, Egg, Meat & Fish, Pulses & Products and Milk & Products”. Vegetable inflation, a key driver of food inflation in the past few months, saw inflation drop from average of 24.8% between April 2024 and January 2025 to a negative -1.07% in February 2025. This decrease in inflation in items was attributed partially to a high base along with an improved crop output. Going forward too, the outlook for food inflation is benign, as both summer and winter crop production are estimated to rise on a YoY basis, which will also help to reduce volatility as it creates a buffer. Core CPI has been inching up, but a key driver has been rising prices of gold and silver which are up as much as 30% YoY. Ex-Gold and Silver, Core CPI is low at <3% YoY.
More Room for Policy Rate Cuts
CPI Inflation at 3.6% and Repo rate of 6.5% implies a real policy rate of ~2.9%, which is significantly higher than the neutral policy rate range of 1.5% to 1.9%. In fact, the latest minutes show that some monetary policy committee members highlighted that high real policy rates “are a drag on private capex and a leading factor why the investment rates remain below what is needed for a high growth rate.” Thus, lower inflation clearly increases the room for further policy rate cuts.
Liquidity Situation to improve post Advance Tax Payments
RBI has been proactively infusing liquidity in India via OMOs, Forex Swaps, Variable Rate Repos, and the CRR cut announced in December. These have had a cumulative liquidity infusion of ₹6.28 lakh crore since December 2024. With the seasonal pattern changes (advance tax deadline of 15th March behind us) along with liquidity infusion by RBI, liquidity conditions could improve by end-March. Overall, system liquidity has improved substantially from the recent tightness and is likely to continue to remain in a comfortable zone over next 6 to 12 months, subject to RBI’s forex interventions.
Conclusion
Inflation being lower on a durable basis has been a key outcome from the establishment of the Monetary Policy Committee with a Flexible Inflation Targeting mandate. Lower durable inflation keeps long term interest rates low, which could lower borrowing costs for the Government, while also supporting capital investment in the economy.
Lower inflation in the near term along with an outlook for moderate inflation opens up the space for more rate cuts, which is positive especially considering the challenging growth environment particularly from a global standpoint. With an increased probability of further rate cuts, Indian Economy could see a further boost to consumption.
Various factors indicate fixed income rates could be lower in the near to medium term, such as slowing global and domestic growth, likelihood of moderation in INR volatility, favourable policy outlook and increasing liquidity. Thus, we maintain our positive view on fixed income markets and believe that yields are likely to trade within a range with a downward bias. Investors could therefore consider investing in products with higher duration (>5 years).
Sources: RBI, CMIE, Bloomberg, and other publicly available information
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