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Central bank rewards ‘goldilocks’ phase, more rate cuts on horizon

Explained | Economics | Mains Paper 3: Indian Economy

Introduction

India’s macroeconomic landscape has entered a period of moderated inflation and sustained high growth. This phase is termed a “Goldilocks” period, characterised by low inflation, stable growth, and manageable external risks. 

Why in the news?

The RBI’s decision to cut the repo rate to 6.25%, despite global volatility and geopolitical tensions, marks a significant shift after years of inflation-driven tightening. India is witnessing a rare Goldilocks combination of sharply falling inflation, strong GDP growth, and stable financial conditions. Inflation at 2.2% is at a five-year low, and India’s GDP is growing at 8%, far outperforming major economies. 

What defines India’s current ‘Goldilocks’ phase?

  1. Falling Inflation: Headline inflation eased to 2.2%, the lowest in five years, supported by easing commodity prices and base effects.
  2. Robust GDP Growth: India registered 8% growth in H1 2025-26 despite global slowdown signals.
  3. Comfortable Macro Stability: Lower fiscal pressures and stable demand conditions created policy space for rate cuts.
  4. Improved External Position: Reduced current account stress and lower import costs support currency stability.

Why did the RBI reduce the repo rate?

  1. Softening Inflation Trajectory: The MPC noted inflation had remained within the 4% target band and was expected to stay benign in FY26.
  2. Need for Growth Support: Lower rates were expected to incentivise credit-led expansion in manufacturing and services.
  3. Favourable Fiscal-Monetary Alignment: Government spending (especially capex) supported demand without overheating the economy.
  4. Currency Management Flexibility: RBI avoided aggressive support for the rupee, preferring gradual adjustments over intervention.

How is the RBI navigating external and domestic challenges?

  1. Geopolitical Pressures: US tariffs, global trade conflicts, and currency pressures had limited spillovers due to strong domestic buffers.
  2. Controlled Volatility: RBI tolerated a weaker rupee rather than risking excessive use of reserves.
  3. Balanced Liquidity Management: Money market conditions were allowed to ease gradually to avoid credit shocks.
  4. Financial Market Stability: RBI prioritised smooth transmission over abrupt shifts in policy stance.

What do forecasts say about future rate cuts?

  1. More Cuts Expected: Analysts anticipate 75-100 bps more cuts in FY26 if inflation remains under control.
  2. Industry Surveys Support Easing: Business expectation surveys indicate strong corporate confidence and lower borrowing costs.
  3. Housing Market Boost: Home loan rates could drop by 50-75 bps, lifting real estate demand.
  4. Consumer Confidence Strength: Household inflation expectations fell to 16.5%, supporting consumption recovery.

What risks could disrupt the current Goldilocks scenario?

  1. Global Market Volatility: Any sharp rise in crude prices or commodity shocks could push inflation back above the comfort zone.
  2. Currency Instability: Excessive rupee weakness may force RBI to abandon its easing stance.
  3. Capital Flow Reversal: A reversal in global risk sentiment could reduce foreign investment inflows.
  4. Domestic Policy Errors: Overly accommodative monetary conditions may trigger asset bubbles.

Conclusion

India’s rare Goldilocks moment represents a balance between falling inflation and sustained growth. The RBI’s calibrated approach, reflected in the 25-bps rate cut, signals confidence in the economy’s resilience while acknowledging external vulnerabilities. Sustaining this phase will require cautious policy alignment, prudent fiscal behaviour, and continued macroeconomic discipline.

Economic Theory Linkages

Phillips Curve

  1. The Phillips Curve suggests an inverse relationship between inflation and unemployment, implying high growth usually brings higher inflation.
  2. India’s current scenario shows low inflation (2.2%) coexisting with high GDP growth (8%), which breaks this classical trade-off.
  3. This reflects a Goldilocks phase, where supply-side stability, improved productivity, and disciplined monetary policy allow growth without inflationary pressures

Taylor Rule

  1. The Taylor Rule proposes that central banks adjust policy rates based on deviations of inflation from target and output from potential.
  2. With inflation below the 4% target band and growth performing strongly, the rule permits accommodative monetary action.
  3. The RBI’s 25 bps repo cut to 6.25% aligns with Taylor Rule logic, indicating room for easing due to a benign inflation outlook.

Impossible Trinity (Mundell-Fleming Trilemma)

  1. The theory states that a country cannot simultaneously maintain:
    1. A fixed exchange rate
    2. Free capital mobility
    3. Independent monetary policy
  2. The RBI’s choice to avoid aggressive currency defence, letting the rupee adjust gradually while prioritising domestic monetary easing, illustrates a preference for monetary autonomy over rigid exchange rate control.
  3. The trilemma framework explains why India can cut rates despite global volatility but must tolerate some currency movement.

PYQ Relevance

[UPSC 2019] Do you agree with the view that steady GDP growth and low inflation have left the Indian economy in good shape? Give reasons in support of your arguments.

Linkage: This PYQ directly maps onto India’s current Goldilocks phase of falling inflation and strong GDP growth, exactly like the article’s macro narrative. It allows you to connect RBI’s rate cuts, macro stability, and growth-inflation balance to broader economic health.

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