RBI cuts rates amid benign inflation and strong growth: The perfect hook shot

RBI Monetary Policy Review

The Reserve Bank of India’s (RBI) monetary policy concluded on December 5 amid mixed market views and an extremely complex set of data. With the field set tight and bowlers anticipating an edge, the RBI played a confident hook shot for a boundary with a 25-bps rate cut.

The MPC voted unanimously to reduce the policy rate to 5.25 percent. As a result, under the liquidity adjustment facility (LAF), the standing deposit facility (SDF) rate stood at 5.00 percent and the marginal standing facility (MSF) rate and the bank rate remained at 5.50 percent. Additionally, the MPC kept the stance unchanged at neutral with a vote of 5:1, with one external member voting for a change in stance to accommodative.

The real GDP growth was printed at an 18-month high of 8.20 percent in Q2FY26. Additionally, high frequency indicators suggest that domestic economic activity is resilient for Q3FY26; however few leading indicators are showing signs of softening. Also, the kharif crop production in FY26 is expected to be higher than in FY25 as per the first advance estimate. The downside to growth remains the uncertainty of the India-US trade deal and other external shocks. Given these factors, real GDP growth forecasts by RBI are as follows: FY26: 7.30 percent (6.80 percent) ; Q3FY26: 7.00 percent (6.40 percent); Q4FY26: 6.50 percent (6.20 percent); Q1FY27: 6.70 percent (6.40 percent); Q2FY27: 6.80 percent with risks evenly balanced.

The headline inflation in October 2025 was reported at 0.25 percent, which has been the lowest in the CPI series. This is primarily led by deflated food prices. Core inflation has been over 4 percent due to heightened metal prices. However, according to the World Bank Commodity Price Forecasts, except for some metals, international commodity prices are likely to tone down going forward. Considering all the factors, the inflation projections are as follows: FY26: 2.00 percent (2.60 percent), Q3FY26: 0.60 percent (1.80 percent), Q4FY26: 2.90 percent (4.00 percent); Q1FY27: 3.90 percent (4.50 percent); Q2FY27: 4.00 percent with risks evenly balanced.

On the liquidity side, system liquidity has remained at an average of Rs 1.5 lakh crore since the RBI’s last October 2025 policy. Additionally, the RBI has taken steps to infuse liquidity in the banking system by OMO (Open Market Operations) purchase for Rs 1 lakh crore in two tranches of Rs 50,000 crore each on 11th and December 18. Also on December 16, the RBI will enter into a USD/INR buy-sell swap worth $5 billion for a period of three years.

During the post-policy press conference, the Governor reiterated the significance of maintaining benign inflation and ensuring effective monetary policy transmission. He stressed that surplus liquidity in the banking system is essential for transmission to flow into the real economy. The Governor reiterated that RBI is committed to providing sufficient durable liquidity to the banking system.

On the forex front, the Governor clarified that RBI does not target a specific rupee level, stating: “Our effort has always been to reduce any abnormal volatility in the forex market. We just let the rupee find its correct position, correct level”.

Bond Markets welcomed Friday's 25-bps cut, with the 10-year G-sec yield slipping 3 bps to ~6.48 percent. Given the overall outlook on the banking system liquidity and the Governor's assurance of providing durable liquidity, we expect more OMO purchase announcements in the early part of Q4FY26.

With the 25 bps cut in December 2025, the bar for further rate cut is a little higher in this cycle, and the same will be determined by growth–inflation dynamics going forward. However, if we see the spread between 10-year G-sec and repo, the same is around 120 bps, which is higher than the last 10 years' average of 105 bps. Overall, it was a well-balanced policy, and we expect a long pause in this cycle—much like a batter choosing not to swing at every delivery after finding the boundary early in the test innings.