Reference Article: The Hindu

UPSC Relevance:
– GS Paper III: Indian Economy – Growth, Inflation, Monetary Policy
– Prelims: CPI, RBI’s inflation targeting framework, Monetary Policy Committee (MPC)

India’s retail inflation (CPI) for September 2025 dropped to 1.54%, the lowest in 99 months, marking a sharp slowdown in price pressures and signaling an emerging demand-side weakness in the economy. The average inflation rate for the first half of FY26 stands at 2.2%, well within the RBI’s comfort band of 2%–6%.

Key Data Points

• Average inflation (Apr–Sep FY26): 2.2% — lowest since inflation targeting began.
• RBI’s comfort band: 2%–6%, with a target of 4%.
• Inflation in key segments such as clothing and footwear stood at 2.3%, continuing its two-year downward trend.

Implications

1. Policy Dilemma for the RBI

The RBI has consistently reiterated that its target is 4% inflation, not merely staying within the band. With inflation now far below this level, the central bank faces a policy dilemma: should it act to lift inflation towards the target as actively as it once sought to curb it? Persistently low inflation reflects excess supply and weak domestic demand, rather than policy success alone.

2. Weak Domestic Demand

Despite tax cuts and incentives, households have preferred to increase savings and reduce debt rather than spend more. Income-tax rebates and GST rate reductions led only to temporary surges in consumption. Meanwhile, India’s exports remain constrained by tariff tensions, and unlike China, India cannot rely on external demand to offset domestic weakness.

3. Private Sector Role

Private sector investment announcements have risen in the first half of the year, but these commitments need to translate into tangible projects to create jobs and increase wages. A sustained rise in real wages is vital to revive consumption demand and prevent the economy from slipping into stagnation.

Policy Recommendations

1. Monetary Policy Response

With inflation well below target and private investment requiring momentum, the RBI should consider a significant interest rate cut in the December 2025 MPC meeting. A more accommodative stance would encourage credit growth, stimulate consumption, and support economic recovery. At this stage, it is better to err on the side of support rather than conservatism.

2. Improve Forecasting Accuracy

In April 2025, the RBI projected inflation at 4% for the year but revised this to 2.6% by September. Such sharp revisions in a short span highlight shortcomings in the central bank’s forecasting models. Improving inflation estimation is critical for maintaining credibility and ensuring that policy decisions are data-driven and forward-looking.

Macro Perspective

While low inflation may appear beneficial, excessively low inflation can slow growth by discouraging investment, suppressing wage growth, and increasing the real burden of debt. A mild level of inflation, around 4%, is generally considered ideal for sustaining healthy growth and employment.

Conclusion

The record-low inflation rate offers short-term comfort but raises long-term concerns of weak demand and potential deflationary pressure. The RBI’s immediate challenge is to restore balance between price stability and economic dynamism. A judicious rate cut, supported by improved forecasting and coordination with fiscal policy, can help realign India’s growth trajectory without compromising stability.

UPSC Mains Practice Question (GS Paper III):

“While controlling inflation is vital, excessively low inflation can be equally harmful for growth. Examine in the context of India’s recent retail inflation trends and RBI’s policy response.”