RBI holds rates steady, signals confidence in growth and inflation management

Shanti Ekambaram, deputy managing director of Kotak Mahindra Bank

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) has unanimously kept the key policy rates unchanged and retained its “Neutral stance”, weighing in the existing favorable scenarios of stable growth, low inflation, ample liquidity, a steady monetary transmission and a robust financial sector against the emerging external environment, clouded by the ongoing tariff wars and intense trade discussions, on India’s growth trajectory. This decision disappointed some market participants who had anticipated a rate cut.

Moreover, RBI has retained its growth projections and moved average inflation estimated for this year lower. However, they have kept Q4 FY26 inflation unchanged and have projected inflation in Q1 next fiscal at 4.9%. The narrative of stable growth and forward estimate of inflation is likely to be over 4.5% pretty much rules out any rate cuts this fiscal and possibly pegs 5.5% as the terminal rate.

The RBI seems to have taken much comfort from the well-coordinated and complementary functioning of the monetary, regulatory and fiscal policies that are working together to sustain economic growth through Tax, rate cuts, liquidity and policy initiatives.

The key high-frequency economic indicators are mixed with relatively healthy, rural consumption which remains resilient on account of better monsoons and better agricultural output. Urban consumption has slowed, but the combined impact of tax and rate cuts is expected to stabilize this segment.  Government capex has been buoyant while private sector capex has been slow.

Capacity utilization has held firm, and growth in the construction, trade, and services sectors has been steady. Additionally, favorable financial conditions and subdued inflation should support domestic economic activity.

A favorable inflation environment in FY26: Inflation in June touched a 77-month low of 2.1% - a sharp decline in food inflation, led by better agricultural activity and the supply side measures taken earlier. Fuel group inflation moderated to around 2.6% in June, while core inflation—range-bound during February to May—has risen to 4.4% due to higher gold prices.

The steady progress of the Monsoon, healthy kharif sowing, adequate reservoir levels and comfortable food stocks, combined with a favorable base effect, continue to give much comfort to the monetary policy makers and for the moment, the CPI inflation for FY26 is seen at 3.1%. Thus, the outlook for inflation in FY26 is benign. However, from Q4 FY26 inflation is expected to go up and next year be above 4.5% with unfavorable base effects and demand side factors start exerting their weight on this key indicator. The CPI inflation estimate for Q1 FY27 is projected at 4.9%.

External uncertainties remain an overhang:  The overwhelming uncertainty emerging from the external environment, especially since the last few weeks, due to intense tariff announcements and trade negotiations is not only posing risks to global financial markets but also challenges to economies like India in terms of the growth outlook. Thus, taking these factors into account, the RBI has kept the real GDP growth projection for FY26 at 6.5%, but with the Q4 outlook tapering slightly down to 6.3%. However, the real GDP growth is expected to improve at 6.6% in Q1 FY27, by when, much of these uncertainties could be behind us.

The monetary transmission of the earlier cuts has started while the system liquidity has been in surplus, on an average of Rs 3 lakh crore per day since the last policy as against the average daily surplus of Rs 1.6 lakh crore during the previous two months. The comfortable liquidity has reinforced the transmission of the policy repo rate cuts into various credit markets during the current easing cycle. On the external front, India’s current account deficit has moderated due to robust services exports and strong remittances. The gross FDI has also remained strong during April-May FY26 while the net FDI moderated during this period due to higher outward FDI.

No rate cuts seen in FY25: Given the above and the clear and logical narrative of the Governor I don’t see any further rate cuts this fiscal unless economic growth undershoots all estimates or inflation shoots up beyond its tolerable levels based on external and internal factors including a depreciating rupee.

The Reserve Bank has proactively supported growth by front-loading rate cuts and ensuring adequate liquidity in the system and remains proactive with a ‘facilitative monetary policy,’ basing the decisions on the incoming data and the growth-inflation dynamics. It has conveyed this commitment in no uncertain terms with impending CRR cut, kicking in September this year. However, it has another key data point – the geo-political tensions and the impact of tariffs playing out on the growth – to watch out for before taking further actions.

At present, macroeconomic conditions remain supportive, and the subdued inflation environment provides the central bank with sufficient policy space to respond proactively if needed. And if the private consumption and the corporate capex pick up in due course, India could weather the external storm well, without much economic impact.