Disinflation meets MPC hesitation as RBI fears inflation edging higher next year

Radhika Rao

The RBI Monetary Policy Committee left the repo rate unchanged in a unanimous vote, with the policy guidance neutral and non-committal, reflected in the MPC’s sanguine and balanced view on growth.

Bond yields ticked up in the wake of the announcement as markets priced out the likelihood of further rate cuts. The steepening yield curve is, meanwhile, capturing the essence of end-of-rate-cycle trends.

Despite a downward revision in the inflation numbers, the RBI preferred to take a forward-looking view, expecting inflation to edge higher next year. We had highlighted the risk that, beyond the ongoing disinflationary spell, inflation would edge past 4 percent by early 2026, similar to trends seen between 2016 and 2019. Core inflation also received a mention, suggesting that policymakers will also give that gauge weight, especially when food and fuel introduce volatility in the series.

The RBI MPC has delivered monetary easing via cuts and liquidity upfront. Pending cash reserve ratio cuts have been pre-committed to. Henceforth, the committee is likely to be guided by growth rather than inflation in the months ahead. The neutral guidance has raised the bar for further rate cuts. A window to lower rates might emerge in October, though it will require a significant growth shock to convince policymakers to ease further. One year ahead, factoring in the April–June 2026 inflation forecast at 4.9 percent and the repo rate at 5.5 percent, the real rate buffer will narrow significantly to 60 bps vs the preferred 140–190 bps. The terminal rate is likely to stay at 5.5 percent this year.

In the post-policy commentary, the RBI MPC highlighted that global developments are not viewed as a direct risk to growth or inflation. The heavyweight food component and dominant presence of non-tradables are expected to limit the first-order impact of tariffs and related developments. Prima facie, our tariff analysis, involving export elasticities, suggests that growth faces a downside risk of ~25-30 bps if tariffs were applied uniformly. Current exemptions on pharmaceuticals and electronics (since April) will shield about one-fourth of India’s exports to the US, in essence lowering the effective tariff rate and its net impact.

Catalysts for tariffs have expanded beyond economics and trade into geopolitics. In response to US’ action, the Indian government clarified that it had already made concessions in the past four to five months. In addition, India’s crude purchases from the US in April–May 2025 already stood at 40 percent of the full-year FY25 scale, suggesting that the FY26 purchases might top recent years.

During the last two years of strong credit growth, there was pressure on banks to generate deposits to back this demand, in effect widening the wedge between the two. That pressure has partly subsided as loan growth came off the boil in FY26. We, however, note that the varying levels of transmission in rates have also influenced the channels from where credit has been raised, beyond the formal banking system. For instance, the faster passthrough to market-based rates has led to a sharper rise in net corporate bond and commercial paper issuances, which in effect has kept the total resources raised in balance for FY26. As loans fall due or refinancing terms surface, there is also likely to be a higher take-up rate for EBLR-linked borrowings to take advantage of a falling rate regime.