India's Economic Shield: How Low Inflation is Protecting the Nation from Global Trade Storms

Even as global trade faces a turbulent period, particularly with looming tariff deadlines in July, India's economy appears well-positioned to weather the storm. According to economists at the Reserve Bank of India (RBI), robust domestic growth, underpinned by surprisingly benign inflation, should act as a crucial shield against these international headwinds.

Navigating Global Trade Turbulence

The June bulletin from the RBI highlights a significant concern: escalating trade barriers and ongoing geopolitical uncertainties could severely impact the world economy. With the temporary "tariff hiatus" ending in July, the outcomes of these trade policies, alongside the trajectory of global geopolitical events, are set to define medium-term economic prospects. The report doesn't mince words, cautioning that the specter of high trade barriers continues to pose serious risks to global supply chains and overall growth.

Originally, tariff deadlines were set for April, but a pause was initiated after President Donald Trump announced new negotiations with various trading partners, including China, pushing the deadlines back to July.

RBI's Proactive Stance

To preempt any potential slowdown in growth, the RBI has already taken proactive measures. Since February, the central bank has cumulatively lowered the benchmark repo rate—the rate at which it lends to banks—by a significant 100 basis points (bps), bringing it down to 5.5%. (For context, one basis point is equal to one-hundredth of a percentage point).

In a further move, the RBI announced a reduction in the cash reserve ratio (CRR) by 100 bps, bringing it to 3% of Net Demand and Time Liabilities (NDTL). This reduction will be implemented in a staggered manner through four equal fortnightly tranches of 25 bps each, beginning September 6.

India's Resilience Shines

Despite the elevated global trade uncertainty, the Indian economy has demonstrated remarkable resilience. Economists in the report noted that India continues to register the highest growth among the world's major economies, with the latest figures for Q4 indicating a sharp pick-up in momentum.

It's worth noting that the views expressed in this "State of the Economy" report within the RBI Bulletin are those of the economists and do not necessarily reflect the official opinions of the Reserve Bank of India.

A key factor in India's strong position is the moderation of headline inflation. Measured by year-on-year changes in the all-India consumer price index (CPI), inflation cooled to 2.8% in May, marking its lowest reading since February 2019. Crucially, CPI inflation has remained below the government's legally mandated target of 4% for four consecutive months, providing the central bank ample policy space for potential further easing if needed.

Promising Indicators and Banking Dynamics

High-frequency indicators for May paint a picture of resilient industrial activity. The report points to a steady expansion in the Purchasing Managers' Index (PMI) for manufacturing, alongside robust growth in capital goods and steel output.

In the banking sector, both deposit and credit growth have seen some moderation this year. The report also highlights a growing trend among banks to rely more on certificates of deposit (CDs) to meet their funding needs, a reflection of intensified competition within the bulk deposit segment.

Foreign direct investment (FDI) inflows continue to be strong, with gross inward FDI reaching $8.8 billion in April, an increase from $5.9 billion in March and $7.2 billion in April of the previous year. Even after accounting for repatriation and outward FDI, net FDI in April stood at a healthy $3.9 billion, more than double the level recorded in the same month last year.

However, external commercial borrowing (ECB) registrations saw a slowdown, coming in at $2.9 billion during April, down from $11 billion in March and $4.3 billion in April last year. Despite global market volatility, net Foreign Portfolio Investor (FPI) debt withdrawals in May remained below 2% for most of the month, even amidst shifts in the yield differential between Indian and US government bonds.