On Wednesday, the central bank's Monetary Policy Committee (MPC) unanimously decided to hold its breath, leaving the benchmark repo rate unchanged at 5.5%.
With inflation firmly showing signs of easing, the central bank divined a 3.1% inflation rate for FY26, down from 3.7% projected earlier, while real GDP growth rate is left unchanged 6.5%.
Predictably, there was no joy on Dalal Street with Sensex and Nifty trading flat. Having frontloaded policy rate cuts of 50 bps in its previous review in June, the MPC also unanimously voted to retain its policy stance at neutral, which allows the central bank to raise or reduce rates. Yet, the market continues to believe in the low rate fantasy, insisting that the path for rates firmly remains downwards.
A potential rate cut is anticipated in October or later, once data on festive demand, agricultural output, and global trade uncertainties are resolved. Right now, the US is throwing us a curveball as far as tariffs are concerned and preliminary estimates peg a 20-40 bps hit on our FY26 GDP. But it could be even sharper, should President Donald Trump continue to whack us with further punitive levies. Moreover, fuel inflation will take a turn for the worse, should India give in to the US' demands to stop importing Russian oil. For now, the government is standing firm on maintaining its trade ties with Russia.
Meanwhile, a status quo on rates was widely expected, though a few argued for a 25 bps rate reduction in August to avoid a so-called Type 2 errors.
According to SBI Research, such an error occurs when the central bank fails to reject the null hypothesis, assuming that the inflation undershoots is temporary, and hence does not cut rates. In reality, inflation remains persistently low and output gap continues to weaken.
A 25 bps rate reduction now, they argue, will come just in time and gives adrenaline for the race ahead of the upcoming festive season.
But the MPC decided to pause and allow time for the effects of previous measures to filter through the credit markets and the broader economy. As of now, banks are refusing to play nicely and pass on previous rate cuts like a grownup.
Coming to headline inflation, notwithstanding domestic and global macro uncertainties, headline inflation is expected to remain rangebound this fiscal and even next, though it's expected to edge up Q4 of the current fiscal. For FY26, retail inflation forecast is revised downwards to 3.1%, from 3.7% projected earlier. Q2 is pegged at 2.1%, Q3 at 3.1% and Q4 at 4.4%. Likewise, inflation for Q1, FY27 is estimated at 4.9%, higher than RBI's 4% target.
Stating that growth is holding up well, even though high frequency indicators showed mixed signals in May and June, RBI Governor Sanjay Malhotra noted that rural demand remains resilient, while urban demand revival is stepping up. Fixed investments and government capex are supporting growth, while supply side factors such as monsoon and services continue to be steady. However, industrial growth is subdued and uneven, pulled down by primarily by electricity, mining and manufacturing.
Given the above normal southwest monsoon, easing inflation, robust capex, and despite risks such as uncertain external demand, geopolitical tensions, volatility in global financial markets, real GDP for FY26 is kept unchanged at 6.5%. Q1 is pegged at 6.5%, Q2 at 6.7%, Q3 at 6.6% and Q4 at 6.3%.
Growth during Q1, FY27 is estimated at 6.6%.
That said, some believe that given the global trade uncertainties and delays in monetary transmission, RBI may continue to keep rates on hold even during the October policy. Moreover, the US Federal Reserve too is maintaining a status quo, though there's a rising chorus for rate cuts in its September policy even though there are difference of opinions on whether the US is actually witnessing stagflation or a recession.
As Malhotra explained in June, a neutral stance means interest rates can move either way depending on the evolving data. He stated, “It will depend on how the data comes in. If the growth is weaker, it can mean [the repo rate] will go down. If the growth is good, inflation is going up, the repo rate can go up”