RBI policy provides a dovish tweak, bar for further rate easing remains high

RBI Monetary Policy Analysis

In the end analysis, this policy turned out to be more interesting than was being anticipated by any market participant. True, there was no rate reduction, as was being broadly expected, and the stance also stayed unchanged. But the boring part end here as the RBI unleased a host of measures on the regulatory perspectives that seeks to strengthen the resilience and competitiveness of the banking sector, some measures to improve flow of credit and ease of doing business, one more step forward towards internationalization of the INR etc.

On the piece of resilience and the competitiveness of the banking sector, there were four specific measures that could have a wide-reaching impact over the medium to long term. The Expected Credit Loss (ECL) framework requires banks to highlight potential credit stress and provide for capital proactivity to manage the problem account. The implementation of the same has been pushed to April 1, 2027 while giving banks a 4-year period to fully comply with the same, thereby enabling banks to smoothen out any one-time provisioning impact at the start date.

Importantly, it has also been proposed that there would be lower risk weights on certain segments – particularly for MSMEs and residential real estate, including home loans. Effectively, RBI seeks to energize credit flows to critical growth-oriented segments of the economy through regulatory changes. In a similar vein, it is envisaged to create an enabling framework for banks to finance acquisitions by Indian corporates. Furthermore, banks are currently disincentivized to provide loans to large corporates beyond Rs 10,000 crore.

As an overarching policy restriction, this is being relooked at and it is envisaged that concentration risks will now be investigated at the banking system level and will be managed through specific macro-prudential tools, whenever necessary. To boost investments into infrastructure, risk weights applied by NBFCs is proposed to be reduced for operational and high-quality infrastructure projects. Some benefits with respect to time frame of repatriation of foreign currency has also been provided to the exporters to enable them to tide over the difficult times of a stiff tariff regime.

To consider the lower-than-expected inflation prints of the past few months, especially due to contained vegetable prices, and factoring in some impact out of the GST rate cuts, RBI has revised its inflation forecasts lower to 2.6 percent for FY26 from earlier 3.1 percent. Inflation forecasts for the quarters of FY26 have consequently been revised lower. Inflation for FY27 is placed at 4.5 percent.

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On the growth front, the reading continues to be positive. While weak external demand is seen on account of tariff issues, growth resilience is expected via domestic drivers such as favourable monsoon, lower inflation (especially food), monetary support and GST cuts.

Overall, FY26 growth has been revised up to 6.8 percent but H2 is likely weaker than H1, due to tariff related developments that can partially be offset by benefits for consumption out of the GST cuts. FY27 GDP estimate is placed at 6.6 percent.

Our reading of the policy is that while there is a dovish forward guidance, the bar for future rate cuts continue to stay high. This policy call was tricky for the RBI, especially with an inflation targeting central bank being faced with the current inflation reading being less than the lower bound of the FIT regime. There remains a significant dose of uncertainty both for growth and inflation. On the growth side, Indian economy is yet to see any severe downside bias emerging from US tariff impositions, while growth may get some support from the festive demand and the GST rate cuts.

Q1FY26 GDP had surprised on the higher side, leading to the RBI to revise its forecasts higher to 6.8 percent for FY26. For FY27, the Monetary Policy Report reveals that for each quarter of FY27, GDP growth is close to or higher than 6.5 percent (6.4 percent, 6.6 percent, 6.8 percent, 6.5 percent for the four quarters of FY27). Standalone, these growth numbers are not too bad when we look at the global growth conditions. Critically, while the growth numbers are lower than the aspirational levels, it remains a debate if the aspirational levels can be reached by further cyclical easing of policy or through structural measures.

Q3FY26 inflation is expected at 1.8 percent and with a 5.5 percent repo rate, the real interest gap is high at 370 bps. But just as we head to Q4FY26, the inflation forecast is 4.0 percent, thus closing the gap to only 150 bps. Further out into Q1FY27, with inflation forecast at 4.5 percent, the gap closes further to 100 bps. A forward-looking central bank is probably weighing this and the risks of excessive easing and then risking a fast turn if inflation were to surprise higher.

Overall, the wait-and-watch policy of the RBI is prudent as it factors in incoming data prints into its reaction function. While the forward guidance remains dovish, the bar for further rate easing remains high.

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