Extended pause in RBI’s policy rate has likely started

The RBI Governor highlighted that the continued focus is on maintaining sufficient liquidity in the banking system to meet the productive requirements of the economy.

The Monetary Policy Committee’s (MPC) August 2025 policy provided mixed outcomes vis-à-vis our expectations, following the unexpected frontloading of rate cuts and the shift in the policy stance in the June 2025 meeting.

After having cut rates by 100 bps (basis points) over the previous three policy reviews, the MPC unanimously chose to keep the policy rates unchanged despite paring the CPI projections for FY2026 quite sharply by 60 bps. Unexpectedly, it maintained its GDP growth projections for the fiscal at 6.5%. However, it maintained its neutral stance in line with expectations, while striking a rather balanced tone in the policy document.

Lower inflation forecast was expected

The cut in the MPC’s FY2026 CPI projections, to 3.1% from 3.7%, is not very surprising, and largely aligns with our own projections (+3.2%, with downside risks). The revision is entirely driven by a paring in the Q2 and Q3 FY2026 estimates, which largely reflects the softer-than-usual sequential build up in food prices, particularly vegetables, in the ongoing year. The Q4 FY2026 and the freshly issued Q1 FY2027 print, are set to see an unavoidable base effect-led upswing to 4.4% and 4.9%, respectively.

Encouragingly, adequate rain has supported healthy kharif sowing: rainfall is now just 3% above normal, and 85% of the normal kharif sowing has already been completed at an appreciable YoY (year-on-year) growth of 5%. We expect this season to end with sowing being around 2% higher than last year.

Early sowing should also be supportive of higher yields. Augmented reservoir levels also augur well for the upcoming rabi season. All these trends have lowered the risk of a sharp broad-based rebound in food prices, notwithstanding any adverse weather shocks or episodes of concentrated rainfall around the harvest time.

Surprise lay in keeping GDP forecast unchanged

The unchanged GDP growth projections infused surprise into this policy. We had expected the MPC to pare its GDP growth estimates from the high 6.5% to 6.0-6.2%; our own estimate for the fiscal now stands at 6.0%, given the visible adverse impact of the weakness in external demand, tariff-related developments, and heightened global uncertainty on India’s exports and private capital expenditure plans. While the Committee did acknowledge these risks, it has not tempered its GDP growth forecast just yet. We expect the pace of GDP growth to taper down in Q2, Q3 and Q4 FY2026, with the latter two quite likely to print sub-6%.

We believed that the soft inflation readings for Q1 FY2026, and the relatively benign outlook for the next two quarters, coupled with an anticipated downside in the GDP estimate (that eventually did not materialise) would nudge the MPC to cut the policy rate now, instead of waiting for additional transmission of the past 100 bps of repo cuts to take place.

MPC ignores the chance for a final rate cut

Overall, we had surmised that the MPC's August 2025 meeting would either bring a final rate cut, or kickoff an extended pause. With unchanged rates in this meeting, we suspect that an extended pause is now underway. By the time the data starts showing a slowdown in quarterly GDP growth prints (Q3 print to be released at end-February 2026), inflation will likely have normalised to above 4%. This would surely constrain further monetary easing, going ahead. Bond yields seem to concur with the expectations of a continued pause, with the 10-year yield having risen after the policy statement.

On the liquidity front, the RBI Governor highlighted that the continued focus is on maintaining sufficient liquidity in the banking system to meet the productive requirements of the economy as well as ensure smooth transmission to money and credit markets. The liquidity surplus, to the tune of ~1.3% of NDTL (net demand and time liabilities), that was seen in July 2025, aligns with this statement.

The upcoming CRR cut of 100 bps during September-November 2025 is set to augment liquidity further by ~Rs. 2.5 trillion, which will facilitate the further transmission of the 100 bps rate cuts to bank lending rates. This may prompt a shift in credit offtake to the banking system away from the bond and CP markets, which have seen a faster transmission following the rate cuts that were done between February 2025 and June 2025.

Trade tensions have gotten more protracted in the last week, and there is no telling how long these will last before the dust settles. In the meantime, private capex plans are sure to take a back-seat, regardless of the rate easing and liquidity supportive measures announced so far.