The credit policy has four main points of interest. The first is the repo rate, as it sets the tone for what banks can do on the deposit and lending rates that affect both savers and borrowers.
The second is the stance—which can be neutral or accommodative, or indicate a withdrawal of accommodation. It is a nebulous concept that is of interest more to a market player. One is not sure if it means that in future rates can go up or down. It does not refer to liquidity, as central banks always ensure that there is adequate liquidity.
The third and fourth points of interest are the forecasts of GDP and inflation rate. In these uncertain times, these are even more important than usual as they provide important signals. Normally, forecasts would hold good for at least six months. But with the external environment being quite volatile, views can change every two months. Therefore, these forecasts acquire more importance. Even a 10-basis-point change in forecast in these two variables can signal whether the growth potential or inflation perspective has changed.
Against this background, the RBI’s Monetary Policy Committee has opted for an increase in the repo rate by 25 bps. The decision has been quite unanimous, which is not surprising as in the past, too, there has been a tendency for all six members of committee to form a group-think. Rarely has there been dissent, with just a few instances of only one member holding an opposite view.
Further, the stance has changed to calibrated tightening. This is a new concept brought in, and one can guess that there will be more rate hikes in the coming months. It has been explicitly stated that rate cuts are off the table and there will be hikes or status quo in future. This is significant from the point of view of markets, which were still uncertain of the timing of the rate hikes. There will be conjectures, however, on how many more rate hikes would be in the offing.
What can one make of these decisions? First, this is the beginning of a series of rate hikes—possibly another two by March 2027. Going by an inflation forecast of 5.2 percent for the year, the terminal repo rate in this cycle should be at least 6 percent, which will yield a real rate of 1 percent, which should be acceptable. There are, however, varying estimates of what this ideal real rate should be, ranging from 1.5 percent to 2 percent.
The impact of this rate hike will get transmitted automatically to the lending rates as nearly two-thirds of loans are linked to the external benchmark, which is the repo rate or Treasury bill and the government security rate. It would need to be seen whether some banks choose to give concessions to enhance market share, especially for personal loans that tend to increase during the festival season.
However, on the deposits side it would be interesting to see how banks react. There has been a deluge of dollars due to the foreign currency scheme for non-residents which has been converted into rupees by banks. This has lowered the banks’ dependence on bulk deposits; and access to the certificates of deposits market has come down.
In such a situation, there could be fewer compelling reasons for banks to increase deposit rates which, in turn, will mean that transmission of the repo rate hike can get sluggish at this end. It will be banks which have fewer surplus that will tend to raise deposit rates at the retail end. Therefore, the transmission part would have to be observed, and it looks like there will be time-lags involved given the current situation of surplus liquidity in the system.
The GDP forecast has gone up from 6.7 percent to 7.1 percent while inflation assessment for the future is up from 5 percent to 5.2 percent. The upping of the GDP forecast is something that was expected as the quarterly growth number came in at 7.8 percent for the first quarter (April-June 2026), which was much higher than expectations.
It is expected that Q2 will also register similar growth as the base year change has led to substantial declines in GDP numbers for Q1 and Q2 of 2025-26, which will prop up the number for this year.
But beyond the first half of the current year, there will be a slowdown as the monsoon failure will have an impact on both agricultural production as well as rural consumption, which will be watched closely as the kharif crop is harvested October onwards. The change in the RBI’s forecast for GDP growth is aligned now with what most global agencies did in the last month or so, given the rather impressive performance of the real economy.
The forecast for inflation is rather interesting. It has been put at an average of 5.2 percent for the year; but that for the next few quarters is significant. The forecast for Q3 is now at 6 percent, which will moderate marginally to 5.7 percent in Q4. Further, for Q1 of the next year, inflation is to increase to 5.6 percent. Hence, after Q2, which has gone past, inflation will average 5.8 percent for the next three quarters.
For the year, the RBI has projected core inflation—which is the non-food and non-fuel calculation—at 4.4 percent. These numbers probably factor in the higher food prices that will evolve as the kharif crop gets affected by the sub-normal monsoon. There can be an upside here in case the oil marketing companies decide to increase fuel prices—which have been held back after the first hike a few months back.
On liquidity, the RBI has not announced any specific measures. The surplus in the system today is over ₹5 lakh crore and there were expectations of the central bank announcing open market operations—where the RBI sells securities to banks. It is clearly adopting a wait-and-watch approach on this, and has only maintained it will work towards aligning overnight call rates with the repo rate. This means that there will be close monitoring of liquidity with variable-rate reverse repo operations to absorb surpluses. The surpluses could also reduce in case credit growth picks up further.
The RBI policy, always something to look forward to for a succinct overview of the economy, comes just after the Union finance ministry released its own view. The sense one gets is that the economy is doing well and the main risk factor is rising inflation, which the monetary policy is seeking to address.
Madan Sabnavis | Chief economist, Bank of Baroda, and author of Policies that shaped Modern India
(Views are personal)
