Rates unchanged, but RBI governor brings a loaded cannon of strategic measures
The RBI preferred to nibble at the edges, keeping rates unchanged on Wednesday.
The central bank, however, indicated that it may roll the pitch in December, by which point clarity will emerge on whether tariff uncertainties can be dismissed as trivial trouble. Moreover, festive demand trends will provide a clearer view of growth potential amid external demand volatilities.
The key short-term benchmark rate stands at 5.5%, the Standing Deposit Facility at 5.25%, while the Marginal Standing Facility and base rate are held at 5.75% each. The RBI also decided to retain the policy stance as neutral.
There were no rate cuts; yet, Wednesday’s policy outcome was far from a non-event, as Malhotra came with a loaded cannon of strategic measures aimed at lifting exporters and domestic financing. The central bank is taking firm steps towards the internationalization of the rupee, with the RBI allowing neighbouring countries to take credit in rupees. Moreover, offering flexibility to exporters, Malhotra increased the timeline for the realization of export proceeds in rupees from one month to three months, supporting rupee invoicing.
In addition, the RBI also announced a series of thoughtful and forward-looking measures, expanding bank financing to include M&A activity, increasing limits on capital market exposures, and rationalizing the large exposure framework for efficient capital allocation. Lastly, the reduction of risk weights for infrastructure lending by NBFCs is expected to reduce the cost of capital for critical sectors.
Coming back to rate cuts, so far, the central bank has reduced the repo rate by 100 bps in three tranches beginning in February, and RBI Governor Sanjay Malhotra believes that the frontloading of rate cuts is yet to fully work its way into the economy.
A rate cut at this point may have cheered borrowers jockeying for lower interest rates, but given that the RBI’s decisions are taken with foresigh and because rate cuts or hikes work their way through the economy with lags, a reduction right now could have only confirmed the worst fears: that the economy is entering a danger zone.
That said, Malhotra did confirm that domestic demand remains weak and the growth outlook is clouded due to elevated global policy uncertainties, even as tariffs are expected to moderate exports. So, the RBI decided it is prudent to wait and see whether the structural reforms announced in August, softening inflation, and GST rate cuts can offset the impact.
The Monetary Policy Committee’s (MPC) decision is never as simple as a child’s workbook, but often, policy watchers can clearly sense the direction it is headed. However, October’s policy saw dramatic swings, from a unanimous pause to a 25 bps reduction. While some supported a rate cut, others insisted on a status quo, turning it into a close call between a pause and a cut.
Those arguing for a rate cut reasoned that inflation was well within the RBI’s comfort zone of 2–6% and is likely to remain rangebound even into the next fiscal year. Moreover, the recent GST rate cuts and a good monsoon opened up space to ease rates further to support growth.
But others insisted that the rupee is at a record low, and cutting rates may put pressure on the currency by narrowing the interest rate gap with the US. As Malhotra noted, the RBI is keeping a close watch and stands ready to take steps as warranted. As it stands, bond markets too are stuck in nervous territory, with yields on 10-year bonds shooting up by 30 bps since June.
As for growth, though FY26 estimates have been revised upwards to 6.8% from 6.5% projected earlier, Q3 and Q4 are likely to see some slowdown.
This means FY26 may turn out to be a game of two halves, with the first half of the fiscal faring better, while the second half is forced to withstand volatilities.
As Malhotra noted, Q1 saw an unexpected growth upside at 7.8% due to a low deflator, frontloaded exports to the US, and higher government spending. Further, high-frequency indicators suggest that domestic economic activity sustained momentum even in Q2. However, Q3 and Q4 must tough it out on their own.
Despite an above-normal monsoon and adequate reservoir levels leading to better agricultural output, the rationalization of GST rates, which is expected to have a sobering effect on inflation and spur consumption and rising capacity utilization facilitating investments, growth is unlikely to accelerate meaningfully. While tariff uncertainties will impact external demand, volatility in global financial markets is also expected to pose downside risks to the growth outlook.
Accordingly, Q3 and Q4 growth is projected at 6.4% and 6.2%, respectively, while Q1 of FY27 is pegged at 6.4%.
The good news on the inflation front is that overall prices are expected to remain benign, and an above-normal monsoon is expected to keep food prices in check. Forecasts for FY26 have been revised downwards to 2.6%, while Q3 and Q4 are pegged at 1.8% and 4%, respectively. As for Q1 of the next fiscal year, headline inflation is pegged at 4.5%.
Meanwhile, analysts noted that inflation has been easing more sharply than the RBI anticipated, and expect FY26 inflation to settle at 2.4%, factoring in the impact of GST rate cuts. If so, real interest rates will stand at 1.6%, which is within the neutral range of 1.6%–1.9%.
This is also expected to lift growth by about 0.6 percentage points over the next year by boosting discretionary consumption. But escalating trade tensions with the US could more than offset this benefit. If tariffs of 50% on Indian goods persist, GDP growth could be dragged lower by 0.8–1 percentage point. The impact will be most severe on MSMEs, which account for 45% of merchandise exports.
What’s unclear is whether the positive boost from GST cuts, along with structural reforms, is strong enough to counter the escalating trade tensions with the US, which are threatening to spread from merchandise to services exports. If this happens, it will be a major blow, as India’s services exports, at about $98 billion, are higher than merchandise exports of $82.5 billion.
If services exports take a hit, it will also impact our current account deficit, which moderated to 0.2% of GDP, led by services and strong remittance receipts.
