In recent weeks, India’s economic landscape has been characterized by a notable decrease in inflation, even as the country confronts the persistent challenge of a depreciating currencyThe Indian Rupee has fallen to historic lows against the US dollar, raising concerns about the potential impact on the economyHowever, this decline in inflation has prompted speculation regarding an easing of monetary policy, with expectations growing that the Reserve Bank of India (RBI) might implement its first interest rate cut in five years during the upcoming monetary policy meeting.

Recent statements from the newly appointed RBI Governor Sanjay Malhotra, who took office last December, have captured the attention of market analysts and investors alike

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Malhotra's remarks are being scrutinized closely, as they might offer insights into the future trajectory of India's monetary policy, especially given the prevailing economic conditions.

Analysts predict at least a 25 basis points cut.

A media survey has revealed that a majority of economists anticipate the RBI will lower the benchmark repurchase rate by at least 25 basis points, bringing it down to 6.25%. In an even more aggressive scenario, some analysts speculate that the central bank could potentially cut rates by 50 basis points unexpectedly.

Taimur Baig, the chief economist at DBS Bank, has expressed his expectation that the RBI will initiate a "shallow rate easing cycle" with a 25 basis point cut

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The last time the central bank reduced rates was in May 2020, amid the severe economic downturn triggered by the COVID-19 pandemic.

Sajjid Chinoy, a Goldman Sachs analyst, has remarked on the importance of Malhotra’s role and the potential shift in policy communication strategyGoldman Sachs also anticipates a 25 basis point cut in this round, followed by another 25 basis point reduction in April, shifting the overall monetary policy stance from neutral to accommodative.

Ruhul Bajoria, an economist at Bank of America in India, has highlighted that the deferral of universal tariffs by the new U.Sadministration provides the RBI with tactical space to prioritize domestic growth through policy rate cuts.

The Indian government has repeatedly adjusted its GDP growth forecasts downward due to economic performance falling short of expectations

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For instance, the country’s GDP growth rate for the quarter ending September was only 5.4%, representing the slowest growth rate in nearly two yearsThe recent estimates have further revised the growth forecast for the current fiscal year from 7.2% to 6.4%, which would mark the worst performance in four years, should it materialize.

At the same time, the government has raised its inflation predictions from an earlier estimate of 4.5% to 4.8%. After spending the last two years with inflation consistently surpassing the central bank's medium-term target of 4%, it was reported that inflation had exceeded the RBI's tolerance level of 6% for a period last OctoberHowever, a decrease in inflation was observed in the following months with rates falling below 6% again, recording 5.48% and 5.22% for November and December respectively.

One significant factor contributing to the market’s anticipation of a rate cutoff is the presence of Malhotra as the new RBI Governor

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His predecessor, Shaktikanta Das, maintained a steady interest rate at 6.5% throughout his six-year tenureAlthough the RBI's last monetary policy meeting in December kept key rates unchanged, debates within the committee hinted at a shiftDuring this meeting, the RBI had already adjusted the cash reserve ratio by 50 basis points, down to 4.0%, easing liquidity in the economy.

Bajoria mentioned that the new leadership in monetary policy may bring a fresh perspective while potentially adopting different approachesAlthough Malhotra has restrained himself from sharing his monetary policy views publicly, he acknowledged in December's financial stability report that easing inflation would create favorable conditions for monetary policy.

Weak Rupee and Uncertainty in U.S

Trade Policy

While many expect the RBI to eventually embark on a rate-cutting cycle, the persistent depreciation of the rupee will likely complicate the central bank’s ability to relax monetary policy effectivelyWith the dollar's strength causing the rupee to fall 3.6% since early November, it hit a historic low of 87.55 against the dollar todayAny drop in the bank's policy rate could exacerbate domestic inflation, putting additional pressure on the rupee and potentially leading to capital outflows.

DBS predicts that a 5% depreciation of the rupee could elevate domestic inflation by 0.35 percentages, although manufacturers and oil producers may find it challenging to pass on costs completely, given the ongoing economic slowdown.

In fact, the RBI has already taken steps to implement substantial intervention in the forex market to cushion against the possibilities of sudden capital outflows

Bajoria has noted that the likelihood of increased volatility in the rupee due to such interventions is on the riseNevertheless, he believes that while a weak rupee may impact future rate cuts, it should not detract from the fundamental need for monetary policy to support economic growth.

Moreover, Indian observers continue to be concerned about potential policies from the U.Sadministration, including broad tariffsIn 2023, India recorded a trade surplus of over $43 billion with the U.S., and this number exceeded $41 billion in the 11 months preceding 2024. As the U.Spresident emphasizes the reduction of trade deficiencies, India may face tighter scrutiny regarding trade affairsAdditionally, the president's trade policy may strengthen the dollar and U.STreasury yields, leading to elevated U.S