Context

• In May 2025, India's inflation rate fell below 3%, a development hailed by mainstream media as a testament to the RBI's effective macroeconomic management.
• However, a more critical examination reveals a more complex picture. Behind this apparent success lies a troubling rise in unemployment and a broad-based economic slowdown, factors that have received scant attention.
• It is crucial to understand that celebrating inflation control without acknowledging these parallel trends presents a distorted view of the economy and overstates the role of monetary policy in managing inflation.

The Reality of Inflation, Unemployment, Economic Growth

• Inflation and Unemployment: A Split Reality
  • While the reduction in inflation from 3.2% in April to 2.8% in May 2025 is statistically significant, it coincides with an increase in unemployment from 5.1% to 5.8% during the same period, according to the Periodic Labour Force Survey.
  • This disconnect reveals a critical flaw in the public discourse on India’s economy.
  • For those already employed, lower inflation means improved purchasing power. For the unemployed, however, it offers no relief.
  • The celebration of falling inflation thus reflects the interests of a relatively privileged class—those who are already part of the formal economy and whose voices dominate economic commentary.
  • In contrast, the unemployed, particularly the informal and migrant labourers who crowd town centres in search of work, are largely invisible in the inflation narrative.
  • The economic theory dominant in some Western countries, which assumes that unemployment is voluntary due to market efficiency, is simply not applicable to India's complex labour market.
• A Troubling Decline of Economic Growth and Employment
  • Even more alarming is the broader context of economic growth. GDP growth declined sharply from 9.2% in 2023–24 to 6.5% in 2024–25.
  • This significant slowdown should have generated greater concern, especially given the government’s long-standing emphasis on high growth as a policy objective.
  • The rise in unemployment is logically consistent with this deceleration in growth. Yet, while inflation receives front-page treatment, the decline in output and job creation remains underreported.
  • According to provisional estimates by the National Statistics Office, this slowdown is not isolated but spans nearly the entire economy.
  • With the exception of Public Administration, all sectors showed a deceleration in 2024–25. Agriculture was the lone exception, registering strong growth.
  • This divergence in sectoral growth rates offers a crucial clue to the real drivers behind the recent drop in inflation.

Reason Behind Fall in Inflation and Limits of Monetary Policies

• Reason Behind Fall in Inflation: Agriculture, and Structural Shifts
  • The surge in agricultural output relative to non-agricultural sectors has likely narrowed the supply-demand gap for essential goods, particularly food, thereby bringing down overall inflation.
  • Food-price inflation, which had peaked at nearly 11% in October 2024, fell to less than 1% by May 2025.
  • Given that food prices constitute a large share of the consumer price index (CPI), this decline had a significant impact on headline inflation.
  • This trend cannot plausibly be attributed to RBI's monetary policy.
  • The repo rate was increased by just over 10% in June 2022 and has remained unchanged since.
  • It is difficult to argue that such a move two years ago could directly cause the sharp reduction in food inflation seen in late 2024 and early 2025.
  • Moreover, services, many of which are not significantly reliant on formal credit, also saw a slowdown, suggesting that interest rate policy was not the primary driver of economic dynamics.
• The Limits of Monetary Policy
  • The prevailing model of inflation targeting adopted by the RBI posits that inflation can be managed by manipulating interest rates to control demand.
  • However, this approach falls short in the Indian context. Structural issues, particularly those affecting agricultural supply, are more decisive in determining inflation trends.
  • If inflation is caused by persistent excess demand in agriculture, reducing interest rates to contract overall demand is both inefficient and counterproductive.
  • Any temporary success in lowering inflation through monetary tightening would likely be reversed once interest rates are lowered again to stimulate growth.
  • Empirical research supports this view. An article titled ‘Inflation in India: Dynamics, Distributional Impact and Policy Implication’ (published in Structural Change and Economic Dynamics, June 2025) provides econometric evidence showing that interest rates have little impact on inflation in India.
  • Instead, it is the relative performance of the agricultural sector that plays a dominant role.
  • These findings expose a critical weakness in the current policy framework: its over-reliance on monetary tools in addressing what are essentially structural supply-side issues.

Inflation Expectations and RBI’s Policy Stance

• Another argument often made in favour of inflation targeting is that central banks can influence inflation expectations among economic agents.
• However, RBI’s own data shows that household expectations of inflation have remained high and virtually unchanged from March 2024 to May 2025, far above the target of 4%.
• This undermines the theory that the RBI’s policies have anchored inflation expectations.
• Furthermore, the RBI Governor’s recent announcement that the repo rate could be lowered further if inflation continues to decline suggests that monetary policy is reactive rather than proactive.
• If interest rate decisions merely follow observed inflation trends rather than shaping them, then the credibility of monetary policy as a tool of inflation management is seriously compromised.

Conclusion

• The recent drop in inflation in India should not be viewed in isolation from other macroeconomic indicators such as unemployment and GDP growth.
• The data suggests that the decline in inflation is largely due to structural factors, particularly strong agricultural growth, rather than the effectiveness of RBI’s monetary policy.
• Over-emphasising interest rate management while ignoring unemployment and sectoral dynamics paints an incomplete and misleading picture of economic health.
• A more holistic approach is needed, one that acknowledges the limitations of monetary policy and addresses the structural imbalances between agriculture and non-agriculture.