When you take a loan and the bank tells you they’ll reduce the interest rate twice in the coming months, that’s good news for borrowers. Similarly, when central banks lower policy rates, interest rates across the economy tend to decline, easing borrowing costs for businesses and consumers.

According to a recent Morgan Stanley report, India’s Reserve Bank is expected to lower rates by 25 basis points in each of the upcoming Monetary Policy Committee (MPC) meetings in October and December 2025. The projected result: a terminal policy rate of about 5%. Here’s what this means, why it might happen, and what to watch out for.

Why Morgan Stanley Thinks RBI Will Cut Rates?

Morgan Stanley bases its expectations on several interlinked observations:

Inflation is comfortably below target. Headline Consumer Price Index (CPI) inflation is averaging well under the RBI’s 4% target. The report estimates 2.4% inflation year-on-year for FY26.
Disinflationary pressures remain. Key sources of inflation have moderated—food prices are showing soft trends, there’s little input cost pressure, and recent Goods & Services Tax (GST) cuts and indirect tax reforms also contribute to lowering inflation.
Core inflation is benign. While headline inflation is low, core inflation (excluding volatile items like food and fuel) is also relatively stable/range-bound. The core inflation number is 4.2%; “core-core” is lower (3.1%) and has been below 4% for many months. This suggests inflation has broad-based moderation, not just in volatile categories.
Nominal GDP growth is weak. Even though real GDP growth holds up, weak price rises drag down nominal growth. Morgan Stanley projects nominal GDP growth at 8.3% for FY26. Weak nominal growth reduces the cushion for central banks to keep rates high.
Room for easing. Combining low inflation, subdued input cost pressures, and lower nominal GDP growth, Morgan Stanley argues that RBI has room to reduce policy rates without fear of runaway inflation. They expect rate cuts of 25 bps at both the October and December MPC meetings.

What Has Happened So Far: Inflation, Rate & MPC Context?

To understand the significance of the expected cuts, it helps to recall what has been happening so far:

RBI’s inflation target is 4% (CPI); inflation has been below this target for several months.
Core inflation has been more sticky, but is now showing signs of softening.
The policy rate (repo rate) had been raised earlier in previous years to counter inflationary pressures; now, as inflation cools, the shift is toward easing.
In recent MPC meetings, the tone has signaled that while inflation is still important, RBI is watching for sustained moderation before lowering rates.

Projections: Rate Cuts & Terminal Rate

Here’s a table summarizing what Morgan Stanley expects, along with potential implications.

Parameter	What Morgan Stanley Predicts	Implications / Notes
October MPC cut	−25 bps	May reduce repo (or whichever key policy rate) from current to ~5.25% → ~5.00%
December MPC cut	−25 bps	If inflation remains benign, bring rate further down to ~5.00%
Terminal Policy Rate	5.00%	If cuts happen as predicted, this becomes the floor unless inflation picks up
Average CPI Inflation FY26	2.4% YoY	Below RBI’s 4% target; gives room for cuts
Nominal GDP Growth FY26	8.3%	Weak, which underscores less pressure to keep rates tight

From this, if things go as per Morgan Stanley’s baseline, borrowing costs across the economy (for banks, bond markets, housing loans, etc.) are likely to ease in Q4 of 2025. But “terminal rate” here is not guaranteed; RBI will monitor inflation, global risks, and macro stability.

What Could Make or Break These Predicted Cuts?

Even with this favourable scenario, there are risks and conditions that will influence whether rate cuts happen as expected.

Factors that support cuts:

Continued soft food inflation: Food is volatile; if food inflation doesn’t spike (due to weather, supply disruptions), it helps maintain benign headline CPI.
Stability in input costs: Oil, commodities, freight costs remaining stable or falling.
Global conditions: If global inflation cools, supply chains improve, energy prices moderate, that helps.
Tax / indirect tax relief: GST cuts, duty adjustments, other government policy levers reducing costs.

Risks or triggers for holding off or reversing:

Spike in international commodity prices or oil prices (geopolitical shocks).
Adverse supply shocks (crop failures, weather disasters) pushing food inflation.
Currency depreciation raising imported inflation.
Global financial stress (e.g. rising interest rates abroad, capital outflows) pushing up yields domestically.
Fiscal slippage or higher government spending without offsetting outcomes could generate inflationary pressure.

What This Means for Different Stakeholders?

These expected rate cuts (if they materialise) will have varied impacts across the economy.

Borrowers: Home loan, auto loan, business loan borrowers could see lower interest rates. EMIs may reduce, or new borrowing costs decline.
Consumers: With lower inflation and possibly lower interest on credit, spending may pick up, boosting aggregate demand in H2 FY26.
Banks & Lenders: Margins may compress if lending rates fall faster than deposit rates. Also, banks may see lower yield on new advances, but could benefit from higher loan demand.
Investors: Bond investors may benefit from falling yields; equities may get a boost as cheaper finance supports corporate earnings. On the other hand, fixed income investors with older high-rate instruments may see opportunity losses.
Policy makers / RBI: Need to balance easing with inflation vigilance. If inflation starts creeping up, RBI might have to pause cuts.

Forecast vs RBI’s Likely Approach

Morgan Stanley’s forecast is one scenario. What might RBI actually do?

RBI typically moves cautiously: they will likely want to see inflation stable over several months before a cut.
The MPC meetings for October and December are logical points, but RBI may skip a cut if inflation data or global developments are adverse.
The term “terminal rate” being 5% suggests that after December, unless more room arises, further cuts may be limited.
RBI may also use other tools (liquidity management, reserve ratios, etc.) in addition to rate cuts to ensure stability.

Conclusion

Morgan Stanley’s view that RBI may reduce policy rates by 25 bps in October and 25 bps in December, resulting in a terminal policy rate of 5%, comes in the wake of inflation that has been under the 4% target, weak nominal GDP growth, and subdued input cost pressures. If this forecast is realised, borrowers could enjoy relief late in 2025; sectors that are interest-rate sensitive (housing, auto, business investment) may see improved demand.

However, the path is fraught with risks: food or commodity price shocks, global inflation or capital flow disturbances, or sharp depreciation of the rupee could force a more cautious RBI. Observers will be watching inflation numbers, core inflation, food price trends, GST / indirect tax changes, and global developments closely in the coming months.

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