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Inflation undershoots

CPI easing is being driven by favourable base effects, benign energy prices, and indirect tax cuts, even as core inflation trend has been firm due to precious metals. After a 1.7% yoy rise in Jul-Sep25 (2QFY), CPI inflation eased to a record low at 0.25% yoy (DBSf: 0.2% yoy) in October. Food disinflation deepened due to a broad-based correction in perishables (vegetables -28% yoy), edible oils, cereals and pulses (-16%), and spices (-3.3%). Besides base effects, transmission of GST rate cuts also added to the correction in costs, likely most observable in electronics, FMCG counters, clothing, footwear, two-wheelers and autos.

Core inflation, by contrast, was nearly steady at 4.4% yoy from 4.3% month before, on the back of the personal care segment rising 24% yoy (due to higher precious metals), while health, transport, recreation etc decelerated. Our gauge of core core CPI (non-fuel, transport, food, precious metals) slowed to 2.9% yoy highlighted the impact of the GST cuts.

October likely marked the bottom in the current cycle albeit November’s print is currently tracking ~0.5%, lending downside risks to the full-year average. In the near-tern, unseasonal rains might impinge on the supply of fresh food perishables in the near-term, which alongside an increase in import duties on selected pulses, reinforces our view that the bulk of the disinflation in food is likely behind us. In response to potential supply shortages and sensitivities around food costs, we expect authorities to undertake administrative measures, including steps to boost inter-state supplies to contain price increases. We revise down our FY26 inflation forecast to 1.8% yoy (4.0% in FY27).

Policy outlook

Firm growth and inflation undershoot makes December rate decision a close call.

The RBI MPC is likely to lower its inflation forecast sharply at the December’s rate review, while nudging up FY26 growth numbers. We expect Oct-Dec25 inflation to average 0.6% compared to RBI’s estimate at 1.8% and a sub-3% print in Jan-Mar26 vs RBI’s 4% projection. This paves the way for at least 50-60bp reduction in the FY26 annual forecast. Basis the 2QFY26 growth numbers out in late-Nov, the full-year growth might be revised up marginally. Passage of a US-India trade deal before the December rate review, will also be an important input for policymakers.

To make a case for rate reductions despite strong growth numbers, the RBI MPC will likely highlight risks to the forward-looking growth trajectory, with prevailing low inflation providing them with the necessary room to reduce lower rates. While a cut is not a foregone conclusion, we see a more than even chance of a reduction in December – the last in the current cycle. We will reassess this call after the GDP numbers and guidance in the interim.

The central bank’s support will be key for FX and bond markets. Benchmark INR bond yields have held steady in recent sessions, post the auction cancellation (see here) as well as likely secondary market purchases. While a confirmation is awaited, there were signs of an increase in support via secondary market purchases under the ‘others’ buyer category, totaling over INR200bn last week and more underway into mid-November. In a bid to widen support beyond the most liquid papers, expectations are that an announcement on open market operations might follow, which will have a more salutary impact on bonds.

In view of recent hardening in yields, local press cited official sources saying that states had been asked to defer bond auctions to ease supply and prevent crowding out during periods which are already auction-heavy. This might lead to a back-end heavy supply in SDLs at the last quarter of FY26 (Jan-Mar26) when the central government’s borrowing calendar typically lightens up. To recall, a top tax-revenue generating state had rejected all bids due to unacceptably high borrowing costs earlier in the month. States had planned to raise INR 2.81trn in 3QFY26 vs INR 3trn quarter before, with 3Q borrowings likely lower due to two tranches of tax devolution in Oct by the centre, providing a cushion to the revenue accounts.

For INR, the line on the sand appears to have drawn at 88.80, ahead of 89.00 and psychologically key level of 90.00. Intervention presence has been relatively aggressive at the spot as well as forwards/ NDF space, with the central bank also citing the need to dissuade a build-up in speculation bets. As a proxy, FX reserves have fallen by $10bn between end-Sep and end-Oct. Outstanding forwards book was at negative $53bn as of Aug-25.

Continuation of FX intervention will require the RBI to conduct open market operations worth INR 1.0-2.0trn to keep durable liquidity in surplus, likely towards late-2025. A US-India trade deal announcement will trigger a brief relief rally in the currency.

Growth pulse

India’s GST structure was rationalized from 4-5 tiers to two-tiers in Sept – 5% and 18% (plus a higher rate on a smaller pool of sin and luxury items), with the aim of lowering the tax incidence on essentials. With this change, most items in the 28% and 12% were merged with lower tiers (18% and 5% respectively), effective 22-Sep. Effective indirect tax on several FMCG goods were lowered, cement (to 18%), auto (three and two-wheelers), household durable goods, farm inputs, besides education supplies and healthcare products like insurance. Sin tax of 40% will be applicable to high sugar drinks, luxury cars, tobacco etc. Current composition of the tiers suggests that nearly three-fourths of the revenues fall under the 18% bracket.

Lower GST rates will be positive for growth in the second half of the year and FY27, besides improving operational efficiency and expanding the size of the formal economy. Higher elasticity of demand for low-cost FMCG products and durables is likely to make the tax cuts consumption-accretive, with these concessions to provide a one-time boost to growth. We get a gauge on the impact of these changes and festive boost on demand;

• A nationwide survey by the Confederation of All India Traders (CAIT) revealed that the total trade touched INR 5.4trn in goods and INR 650bn in services, setting a new benchmark for economic activity during the festival period. The survey showed that 72% of traders reported higher sales volumes this season.
• Another survey by Ipsos pointed to a pickup in consumer confidence in Oct 2025.
• Ahead of the GST change, NielsenIQ already captured data that the rural markets had continued to grow faster than urban areas for the sixth consecutive quarter, while urban regions continued to rebound, narrowing the growth gap. With fresh catalysts on hand, we expect further pick-up in FMCG sales, especially volumes.
• Two/ four-wheelers auto dealers cited sharpest ever Sept sales and likely Oct, with higher footfalls in wake of the GST rate cuts.
• Manufacturing PMIs have also been upbeat, rising to 59.2 in Oct, with firms raising output by the fastest pace in a decade.
• Bank credit growth improved in Sept, up 10.2% yoy from average 9.4% in 1QFY. This might also be reflective of part substitution effects as bond yields have hardened in the past two months impinging on fresh bond issuance, thereby shifting demand from markets back to loans (India: Rate pause, liquidity and credit growth).
• Digital payments during this period have picked up sharply, with value of transactions at a record high at INR 2.7bn in Oct up from INR 2.5bn in Sep, according to PTI. This might not be entirely due to GST lift, but festive and seasonal as well.

Improvement in economic activity in Sept and Oct is likely to be viewed via two lens: a) added overlay of festive demand; b) lull period between mid-Aug to late-Sep (when GST cuts were indicated but not implemented), before an L-shaped improvement post late-Sep. This lens might temper the read on the sharp extent of pick up since late-Sep.

Post one time boost from lower GST rates, focus will shift to drivers to sustain this momentum. Maintaining our focus on domestic anchors considering global headwinds, we expect support from other levers, rate cuts, transmission of past reductions, regulatory measures, support for tariff-hit sectors, strong monsoon, low inflation and surplus liquidity. Higher capital spending is also expected to be a key form of support, even as revex allocations slow to keep within targets (see fiscal section).

2QFY26 (Jul-Sep25) GDP growth data in end-November is unlikely to capture the full impact of the GST changes, as it took effect in late-Sept.

Despite this, we revise up 2Q and full-year FY26 growth numbers. Jul-Sep25 real GDP pace is expected to benefit from statistical effects like a low base (2QFY25’s 5.6%), and weak deflators. In terms of drivers, we expect government spending, rural consumption, and frontloading of exports to have perked growth, while private sector investments and sector-specific drag (for instance IT) weighs. We revise 2QFY26 real pace to 7.5% yoy, vs 1Q’s 7.8%, which will take the 1H average to 7.65%. With our 2H projections pointing to an average of 6.7%, full-year FY26 growth stands revised up to 7.2% from previous 6.7%. Notably, low deflators will weigh on the nominal growth pace, which is expected to slow to 8.5%, which is a crucial input for fiscal ratios and corporate earnings. Some of this one-off impact from deflators is expected to fade in FY27, taking real GDP growth to 6.5% and nominal pace back up to 10% (assuming 4% implied deflator).

We published our muti-year view in India 2025-40 outlook: Pivotal juncture.

Fiscal health under watch

At the mid-year mark of FY26, centre’s fiscal revenues are running below budget, raising the possibility of adjustments in spending allocations to meet the deficit target at -4.4% of GDP.

For a start, nominal GDP growth is budgeted at 10.1% yoy but the actual growth is likely to be closer to ~8.5% due to weak deflators, putting additional pressure on the fiscal ratios and necessitating stronger revenue buoyancy (vs FY25 1.0x).

Revenues face a few headwinds. Gross tax collections rose average 2.8% yoy in first half of FY26 (1HFY26), well below the budgeted 12.5%.  This implies the need for over 20% increase in 2H to meet targets. Direct taxes need to grow by 25-30% yoy in second half of the year to meet the nominal revenue targets, with the gap more material in income tax collections. While income tax cuts partly explain the slowdown, corporate tax revenues are also lagging, reflecting tepid corporate earnings.

Concurrently, indirect tax collections i.e. gross GST revenues rose 9% yoy in 7MFY26, below the budgeted 11%.  Notably, the slower pick up in Oct GST collections (capturing Sep transactions) at 4.6% yoy vs 9.1% yoy month reflected consumers delaying their purchases until lower rates kicked in the last week of Sep. Testament to this, domestic GST receipts eased (2% yoy vs Sep’s 6.8%), while imports-related transactions remained firm.

November’s GST data (capture Oct’s trend) will be watched closely to gauge if a discernible pickup in volumes makes up for a shortfall in the value of transactions (due to lower tax rate overlay). Other heads, for instance customs duty contracted in 1H, with excise duties likely the only outlier as collections received a hand from the increase in petrol duties earlier in the year. Notably, the sub-head dividends & profits has been strong due to the central bank’s dividends, which divestments lag with only a tenth of the full-year budget being meet by 1HFY26.

Expenditure rationalisation is likely to be necessary, with early signs that this is already underway. Revenue expenditure, which makes four-fifth of the total outlay, has continued to be on the slow lane (see chart), rising a subdued 1.5% yoy in 1H25 vs 4.2% last year.

On the capex end, disbursements have been relatively more fast paced to make up for lost time in FY25 (due to elections). Capital spending rose a sharp 40% yoy in 1HFY26 vs -14% yoy witnessed in 1HFY25. This takes capex to 39% of full year budget in 1HFY26 vs 27% same time last year. We also note that the rise in capex in 6MFY26 also entailed an increase in loans to advances to the states and other entities, as well as departments like FCI for past dues, beyond pure allocations towards infra. To meet the budgeted targets, revenue expenditure needs to grow by a strong 16.5% in 2H, which we expect will be undershot, thereby keeping fiscal deterioration under control.

Outlook: Revenue underperformance at the half year mark (~0.1-0.2% of GDP shortfall) increases the likelihood that a recalibration in spending outlays will be necessary to keep within the centre’s deficit goalposts. In light of the recent sovereign rating upgrade, fiscal health especially general government (centre and states) fiscal consolidation and moderation in public debt levels, we don’t expect any compromise in meeting the FY26 fiscal deficit targets. With FY27 deficit targets likely to be built into a range, that will leave more leeway to modulate finances with an eye on lowering overall public debt levels.

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