Low inflation and the anticipation of lower interest rates help India offset the drag from tariffs by reducing production costs and boosting consumer spending. The government's recent GST rate cuts on key items and potential further tax reductions, alongside stable prices, reduce business costs and increase purchasing power, supporting domestic demand. Additionally, the Reserve Bank of India (RBI) has policy space to cut interest rates if tariffs significantly hinder growth, making credit cheaper for businesses and individuals, thereby stimulating investment and consumption to counterbalance reduced exports. The Reserve Bank of India's (RBI) decision to keep interest rates steady while signaling a supportive, or "dovish," stance toward future growth. This is done to counteract potential negative impacts on the economy, specifically from new tariffs.
How Low Inflation Helps
Lower inflation means input costs for businesses, such
as raw materials and energy, are more stable or decreasing, improving profit
margins and potentially leading to lower consumer prices. With lower inflation,
the purchasing power of consumers is maintained or enhanced, encouraging them
to spend on goods and services. Low inflation provides the Reserve Bank of
India (RBI) with the "policy space" to reduce interest rates to
support growth without immediately risking overheating the economy.
How Low Interest Rates Help
Lower interest rates make borrowing cheaper for
businesses, encouraging them to invest in expansion, new technologies, and
capital projects, which drives economic growth. Lower rates reduce the cost of
loans for homes, cars, and other durables, making them more affordable and
encouraging greater consumer spending. Lower rates improve the flow of credit
and liquidity in the economy, benefiting sectors like MSMEs and manufacturing.
How Policy Expectations Help
The expectation of further interest rate cuts, or a
"dovish hold" by the RBI, signals continued monetary policy support
for growth in the face of tariff-related headwinds. A stable and supportive
policy framework, with lower interest rates expected, allows businesses and
consumers to plan with greater certainty, boosting confidence and investment.
How Fiscal Measures Complement Monetary Policy
The government's recent reductions in Goods and
Services Tax (GST) rates on essential goods and services directly boost
consumer spending and reduce business costs, creating a strong domestic
counter-force to tariff impacts. The combined effect of lower prices from
inflation and reduced taxes stimulates domestic consumption, which can help
offset the negative impact of reduced exports due to tariffs.
Dovish vs. dovish hold
A central bank signals that it is prioritizing
economic growth and employment over controlling inflation. This is typically
done by lowering interest rates, which makes borrowing cheaper and encourages
spending. This occurs when a central bank like the RBI holds the main policy
rate (the repo rate) unchanged but adopts communication that signals its bias
toward future easing. It is a "wait-and-watch" approach that allows
the central bank to assess evolving economic conditions before committing to a
rate cut.
Key elements of the RBI's recent dovish hold
The RBI's actions and commentary on October 1, 2025,
illustrate this strategy. The RBI's Monetary Policy Committee (MPC) kept the
repo rate unchanged at 5.5% for the second consecutive meeting. The RBI revised
its GDP growth forecast for FY26 upwards to 6.8% (from 6.5%) while
simultaneously lowering its inflation forecast to 2.6% (from 3.1%). This
created more space for potential rate cuts. The central bank acknowledged that
higher US tariffs on Indian exports could weigh on growth in the coming
quarters. By highlighting lower inflation and external headwinds, the RBI
indicated it could cut rates in the future if growth staggers. This is the
"dovish" element of the "hold."
By adopting a dovish hold, the RBI sought to manage
global risks while supporting the domestic economy. New US tariffs on Indian
goods threaten to hurt exports and overall economic growth. By maintaining an
easy monetary stance, the RBI provides continued support for domestic
consumption and investment to offset this external pressure. Lower interest
rates reduce borrowing costs for both individuals and businesses. This
encourages higher consumption and investment, stimulating economic activity. In
the real estate sector, for example, a stable or falling repo rate supports
lower home loan rates, boosting buyer confidence. The RBI's primary mandate is
to keep inflation within its target range of 4% (with a +/- 2% band). By
revising its inflation forecast down, the RBI's dovish hold signals confidence
that it can support growth without risking an uncontrolled rise in prices. The
dovish tone and potential for future rate cuts tend to boost market sentiment.
The stock market, for instance, often reacts positively to news of a dovish
monetary policy.
