Dovish Pause: prudence amidst uncertainty

Aditi Nayar

In what was expected to be a close call between a status quo and a rate cut, the Monetary Policy Committee (MPC) tilted in favour of the former when it met for its fourth bi-monthly policy meeting for FY2026. The decision to stay put on the repo rate was anchored on the need to see a further passthrough of the front-loaded 100 bps rate cuts earlier this year, as well as to wait for greater clarity around the impact of the GST rationalisation and persisting trade-related uncertainties.

The tone of the policy was relatively dovish. The statement clearly articulated that the current macroeconomic conditions and the outlook have opened up policy space for further supporting growth. This was particularly signalled by an expected downward revision in the CPI projections, owing to the GST rationalisation. Besides, two external members even voted in favour of a change in the policy stance to accommodative from neutral, even as the decision to pause on rates was based on a consensus.

The Committee cut its CPI inflation projection for FY2026 by 50 bps to 2.6% from 3.1% in August 2025, on account of the GST rate rationalisation and benign food prices. It scaled back its quarterly projections for Q3 FY2026 (at +1.8%) by a sharp 130 bps, and Q4 FY2026 and Q1 FY2027 by 40 bps each vis-à-vis those issued in the August 2025 meeting. The prints for Q4 FY2026 and Q1 FY2027 are now expected to print at 4.0% and 4.5% respectively, implying that the inflation trajectory remains upward sloping even though the level has shifted downwards largely owing to the impact of the tax changes. The revised quarterly CPI inflation trajectory is in line with ICRA’s projections.

While the MPC has raised its FY2026 GDP growth print by 30 bps to 6.8% from 6.5%, this largely stems from the better-than-expected Q1 FY2026 reading. The expected quarterly growth trajectory beyond Q2 FY2026 has worsened compared to the August 2025 projections. Although the Committee has raised the GDP growth forecast for Q2 FY2026 by 30 bps to 7.0%, this would be offset by the 10-20 bps cut in the projections for Q3 and Q4 FY2026. Besides, the Q1 FY2027 growth forecast has been pared by 20 bps, bringing the forecast range for H2 FY2026 and this quarter to a decidedly moderate 6.2-6.4%. These downward revisions are attributed to tariff-related developments, even as the Committee has highlighted that this would be partially offset by the impetus provided by the rationalisation of GST rates.

The upward revision in the GDP growth projection for Q2 FY2026 is somewhat surprising, given the expected adverse impact of the US tariffs and penalties on exports in September 2025 and the likely slowdown in the growth in the Government of India (GoI’s) capex in the quarter vis-à-vis Q1. While the industrial output growth improved during July-August 2025 compared to Q1 FY2026, the timing of implementation of the GST rationalisation would lead to inventory management in September 2025 to avoid stranded taxes and the favourable demand impact of the same would largely manifest in Q3 FY2026. Corporate tax data also does not signal an impending jump in profitability in Q2 FY2026. At present, we expect the Q2 FY2026 GDP growth to print at sub-6.5%, marking a sharp deceleration from the high 7.8% seen in Q1. However, we largely concur with the MPC’s projections for H2 FY2026.

Given the benign tone of the policy document and the signals in favour of further easing, ICRA believes that a final 25 bps rate cut may be on the anvil either in the December 2025 or the February 2026 meeting. We expect the exact timing of the same to depend on two key factors.

The MPC has consistently focused on the need for transmission, and developments around this would be a key determinant of the timing of the next rate cut. While the transmission of the 100 bps rate cut to the term deposit rates on fresh deposits has been fairly complete, that for outstanding deposits thus far has remained muted at just 22 bps. The pace of repricing of the older deposit base would be key for a further passthrough of the policy rate cuts to lending rates on outstanding loans, which have come off by 55 bps so far. Muted transmission over the next two months could push out the rate cut decision beyond December 2025.

Secondly, uncertainty around growth outcomes remains elevated. The extent of the upside in demand and production on account of the GST rate rationalisation is only expected to become clear once the high frequency data for September-November 2025 becomes available. Besides, the adverse impact of the tariffs and penalties on India’s merchandise exports to the US would be visible in the trade and output data over the next few months. Finally, greater clarity on the services export side, on account of US actions to curtail outsourcing, may emerge in the near term. These data points and information would be key to assess India’s growth outcomes for H2 FY2026 and full-year FY2027. We expect downward revisions in the expected growth trajectory to drive the rate cut decision, rather than the benign CPI inflation outlook, with the latter being driven by tax policy changes and not weaker demand.

Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.​​​