Despite tariff heat, policy easing to stay on track

Tariff rates imposed on India are less than those of most Asean-6 peers, with sectoral carve-outs and exemptions providing temporary relief. That said, exemptions add to a little more than a tenth of the total exports to the US, with other sectors still exposed to higher tariffs. Our growth impact framework marries export elasticities and bilateral trade/sector flows, signalling about 0.3-0.4% of GDP modest downside risk for India. India has steered clear of retaliatory action, instead counting on a successful conclusion of the ongoing bilateral trade agreement with the US next quarter to lower the effective tariff rate on India’s exports to the US.

Despite the tariff heat, multiple domestic data sets -- low oil prices, easing inflation, slower growth and a firmer currency -- have aligned to make way for the Monetary Policy Committee (MPC) to lower rates further. An agreement by key Opec+ producers to raise output from May has further depressed global oil prices, with world growth slowdown risks likely to keep over-supply risks in view.

India’s January-February inflation, combined with our early estimate for March, points to a potential 40-50 basis points undershoot in the actual inflation versus RBI’s quarterly forecast. Our trimmed inflation measures stayed flat, reflecting benign conditions in recent months. Additionally, more than 67% of the inflation basket rose by less than 4% year-on-year at the start of 2025, with only a small pocket above the mid-point of the target range.

Deceleration in vegetable prices is likely to face a hurdle in the June quarter heading into the summer months as the official weather department has cautioned about high temperatures and drier months. While inflation readings might head back towards 4%, we don’t expect a marked departure from the target. Growth, meanwhile, is seen around 6.4-6.5% in FY25 and FY26, down from the 8% run rate in the previous two years.

The rupee was the regional outperformer, rallying 2.3% in the past month, as seasonality and dollar weakness coincided. Barring a knee-jerk weak spell on Thursday on the back of reciprocal tariffs, the rupee continues to benefit from a resumption in foreign inflows into both equity as well as debt markets, also helped by a likely current account surplus in the March quarter. A more notable shift was the authorities’ reaction, especially tolerance for a period of rupee strength against expectations that dollar inflows might be absorbed to rebuild reserves. A stronger rupee is set against the backdrop of ongoing US-India negotiations where non-tariff barriers, including currency movements, are under scrutiny.

Bonds have gained from expectations of further rate cuts and steady purchases under the ongoing open market operations (OMOs). Bond yields slipped further after the RBI surprised by announcing another ₹80,000 crore OMO for April, signalling a strong preference for surplus liquidity to aid transmission. OMOs were already at a four-year high in FY25. April-June quarter is also expected to benefit from a significant RBI dividend payout, estimated to be north of ₹2 trillion. We look for a 25 bps cut in the repo rate to 6%, and a change in stance to accommodative at the April meeting, tapping into the wide real rate cushion.

Policy guidance will be important as markets price in the possibility of at least two rate cuts in the coming months. While confident on domestic developments, the MPC is likely to be guarded on the uncertain global backdrop as trade distortions pose stagflationary risks to the US and raise the risk of slower global trade.

Radhika Rao, executive director and senior economist at DBS Bank