In December, India experienced its second consecutive month of declining annual inflation, reaching a rate of 5.22%, which was slightly below the anticipated figureThis unexpected downturn has raised the prospect of potential interest rate cuts as a response to shifting economic conditions.

Prior predictions from analysts surveyed by Reuters had estimated the inflation rate would settle at around 5.30%. The data released by India’s Ministry of Statistics and Programme Implementation marks the slowest inflation rate recorded since August 2024.

In stark contrast, the inflation rate soared in October, hitting a 14-month high of 6.21%, surpassing the Reserve Bank of India's tolerance ceiling of 6%. A principal driver of this surge was a significant spike in food prices, with vegetables alone seeing a staggering year-on-year increase of 42.18%. On December 24, Sanjay Malhotra, the Governor of the Reserve Bank of India, projected that inflation would moderate to 4.8% by the end of the fiscal year in March 2025.

The annual growth rate of food prices, a crucial metric for the Indian economy, declined from November’s 9.04% to 8.39% in December

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According to the Indian Socio-Economic Index, there was a marked reduction in inflation across various food items, particularly vegetables, sugar, grains, and candiesSpecifically, the overall inflation rate for vegetables fell to 26.56% in December, a significant drop from November's 29.33%, and a remarkable decrease from the staggering 42.18% spike seen in OctoberDespite the downward trend, the prices of peas, potatoes, and garlic defied this pattern and saw upward trends month-on-month, registering the highest year-on-year increases.

Agriculture holds a pivotal role in India’s economic framework, constituting a significant portion of the nation's GDPGovernor Malhotra previously noted in reports that pressures within the food sector are expected to persist throughout the third quarter of the fiscal yearHowever, he optimistically anticipated an improvement starting in the fourth quarter

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This positive outlook is supported by several factors: as winter sets in, seasonal adjustments are likely to stabilize vegetable prices, and favorable harvests attributed to the monsoon season are gradually enhancing market supplyFurthermore, a strong yield from winter crops along with sufficient buffer stocks of cereals is expected to bolster the agricultural sector.

Against the backdrop of a turbulent global economy, India’s economic growth rate has consequently slowedThe December inflation data not only reflects a softening of price pressures but also provides greater flexibility for subsequent monetary policy adjustments by the Reserve Bank of India (RBI). The reported GDP growth rate for India for the second quarter ending September was just 5.4%, a figure that substantially lagged behind economists' predictions and approached a two-year lowWith the slowing economy, the importance of alleviating inflation pressures becomes critically evident

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The RBI might capitalize on this opportunity to implement interest rate cuts to stimulate economic activity, thereby enhancing investment and consumption levels and helping steer the economy back onto a growth path.

In terms of policy implications, the most recent data — alongside growing economic deceleration and indications of a less hawkish stance from the RBI leadership — suggests that the central bank is likely to initiate a easing cycle during its next monetary policy meeting in FebruaryAccording to Harry Chambers, an assistant economist with Capital Economics, a 25 basis point cut in the repo rate to 6.25% is anticipated after the release of the Monday data.

However, the current depreciation of the Indian rupee complicates the path towards easing monetary policyOn Monday, the rupee hit a historical low against the US dollar, falling to 86.58, a nearly 0.7% decline for the day

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A significant devaluation of the rupee could heighten import costs, exacerbating inflationary pressuresShould the RBI lower interest rates during this period, it may narrow the interest rate differential with the US, intensifying the capital outflow, thus compelling the RBI to maintain higher rates to stabilize the rupee.

In the last monetary policy meeting in December, under the leadership of former Governor Shaktikanta Das, the RBI made a controversial decision to hold interest rates steady at 6.5% despite the many fluctuations in the economic landscapeDas led the RBI since December 2016, concluding his term on December 11. Subsequently, Sanjay Malhotra took over, ushering in a new chapter in India’s monetary policy, leaving market participants keenly interested in his policy directives moving forward.

Earlier this month, analysts from Bank of America suggested that India’s GDP is expected to recover by 2025, but they expressed uncertainty about the strength and rebound of this recovery.

The bank posits that sectors such as agricultural production, fuel consumption, core industry recovery, and air travel may remain robust, while credit growth, fiscal conditions, and consumer metrics are likely to linger at lower levels.

Last November, Bank of America lowered its GDP forecast for India for the fiscal year ending March 2025, from 6.8% to 6.5%, which is below the RBI's own prediction of 6.6%.