Continuing with the dovish stance spelt out in the previous (October) policy, the RBI Monetary Policy Committee (MPC) cut the policy rates today by 25 basis points, with immediate effect, while retaining a neutral policy stance.
Over the past few days, market participants were divided in their expectations from the policy, with the extremely low inflation prints hinting at a rate cut while the strong growth and the recent Rupee depreciation raising the possibility of status quo. However, as we were expecting, the MPC has drawn comfort from the extremely low inflation prints and chosen to support the economy, while also announcing measures to improve durable liquidity.
The MPC is quite satisfied with the growth trajectory with the GDP registering a 6-quarter high of 8.2 percent YoY in Q2 FY26, driven by resilient domestic demand (despite challenging global trade conditions), which was additionally supported by GST rationalisation and cut in Income Tax rates. The robust Gross Value Added (GVA) print of 8.1 percent YoY in Q2FY26 was driven by buoyancy in the industrial and services sectors.
In the RBI’s assessment, high frequency indicators suggest that domestic economic activity is holding up, with oil prices remaining benign, the government front loading its capex and monetary policy remaining supportive; however, there are some pockets of emerging weakness. The RBI has raised its GDP growth forecast for FY26 by 50 bps to 7.3 percent, with Q3 and Q4 forecasts being raised by 60 bps and 30 bps to 7.0 percent and 6.5 percent respectively.
On the inflation front, the MPC has drawn immense comfort from the CPI inflation having printed an all-time low of 0.25 percent in October, with the sharp deceleration in food inflation being the primary driver of the sustained low inflation trajectory. The RBI expects CPI inflation to remain contained, with improved food supply prospects and moderate international commodity prices.
While the record-high prices of precious metals have weighed on core inflation, the non-Gold core inflation has actually moderated to 2.6 percent in October. The MPC has revised further down its CPI projection to 2.0 percent (from earlier 2.6 percent) in FY26, with 0.6 percent and 2.9 percent in Q3 and Q4. It expects the CPI to rise next year to 4.0 percent in Q2FY27.
An encouraging announcement by the RBI (which was also in some way expected by the markets) was on the liquidity front. The Governor announced measures to improve durable liquidity through (a) Rs 1.0 lakh crore quantum of Open Market Operations (OMO) to be conducted in December, as well as (b) a 3 Year US Dollar-INR swap to be conducted in December. It expects these measures to ensure adequate durable liquidity in the debt markets and also aid further transmission of the rate cuts into the banking system.
Our overall takeaway from the December monetary policy is that the MPC, at the current juncture, has preferred to support the economy through monetary policy action, even though there has been a significant pressure on the Rupee over the past few weeks. The MPC has utilised the current phase of extremely low inflationary conditions to cut rates further, while also ensuring abundant system liquidity (LAF: near-term) and durable liquidity, so that the transmission of the rate cuts (125 bps cumulative, so far) continues into the banking system, which will in turn support credit growth.
There was not much mention in the Governor’s speech regarding the INR volatility, which suggests that the RBI, at this point, is not too worried about the INR depreciation, given the healthy forex reserves, but is watching the evolving trade tariff situation and possibly expects some improvement in sentiment going forward.
The unanimity amongst the MPC members with respect to the rate cut decision is encouraging, and along with the reduced inflation forecasts, may keep hopes alive in the market about further policy support from the MPC. However, it would be prudent to think that having obliged with a 25 bps cut in this policy amid the evolving tariff pressure, FPI outflows and pressure on the INR, future rate decisions of the MPC would be more data dependent.
A pause in the next policy in February is more likely, given the fact that the policy stance continues to be neutral, and the MPC might want to see improved transmission of the cumulative rate cuts carried out so far. The fixed income markets should however heave a sigh of relief, as yields had moved up in the run up to the policy. The OMOs should stabilize long term g-sec yields and keep them range-bound in the near-term.
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