Keep calm and carry on is RBI’s message

RBI’s hawkish pause signals a relatively softer downside risk and has some clear takeaways for next few quarters. (Source: PTI)

By Rajni Thakur

On the face of it, much of RBI’s announcements this morning was on expected lines. After frontloading an unexpectedly large 50 basis points rate cut in its previous policy meet in June, the impact of which is still unfolding, keeping the repo rate unchanged is the most prudent policy action that RBI could have taken.

MPC (Monetary Policy Committee) decisions turned live post an unexpected tariff blow to the Indian economy from the US last week. The higher-than-expected tariff (and penalty) proposed by the US pose a headwind to India's growth-inflation dynamics in the ongoing fiscal year. However, even as the tariff situation continues to evolve, RBI’s hawkish pause signals a relatively softer downside risk and has some clear takeaways for next few quarters.

Growth is on track

RBI has retained growth projections for FY26 at 6.5%. The quarterly forecasts were also maintained in addition to a new growth forecast for Q1FY27 at 6.6%. As per RBI’s assessment, conditions for growth continue to remain unchanged and hold strong into the first quarter of next fiscal year as well. The governor noted that the domestic growth has been holding up in line with MPC’s assessment and any tariff related development is currently not much of a concern.

RBI’s assessment of limited impact on macroeconomic conditions gives the much-needed clarity on any potential downside risks from tariff developments.

Inflation undershoot is temporary

Despite sharply lowering its inflation forecast, RBI's decision to keep rates steady emanates from its focus on one-year-ahead expected inflation that's projected above 4%. The full-year inflation projections have been revised downward for FY26 to 3.1% from 3.7% earlier. This was on account of downward revisions made to Q2 and Q3 inflation forecasts, which have been brought down to 2.1% from 3.4% and to 3.1% from 3.9%, respectively. The Q4 projection has been retained at 4.4%, and Q1FY27 inflation has been projected at 4.9%.

RBI noted that the sharp moderation in headline inflation is largely driven by food inflation, which has been supported by supply side measure and higher agricultural activity, while core inflation has edged up to 4.4% mark in Jun’25 amidst higher gold prices. MPC believes that a significant part of the country’s inflation basket consists of food and non-tradeables, which do not get impacted by global developments. To that extent, a first-order direct impact of evolving trade uncertainties on India’s inflation is likely to be very limited.

However, the base effect and pickup in demand conditions will push inflation levels above 4% and to that extent, inflation undershooting target level is a temporary phenomenon for the Indian economy.

Credit growth is normalising and not slowing

Shrugging off concerns on slowdown in credit growth, the governor emphasised that while bank credit growth of 12.1% in FY25 was slower than 16.3% rate of FY24, it was higher than 10.3% average rate in the 10-year period preceding FY25. Also, while bank credit reduced by ₹3.4 lakh crore to almost ₹18 lakh crore in FY25, the flow from non-bank sources more than made up for this decrease. Overall flow of financial resources to the economy increased to ₹34.8 lakh crore in FY25, an increase of almost ₹1 lakh crore over previous year.

Stealth easing will continue via flexible liquidity management: The governor noted that the system liquidity continues to remain in a comfortable position, and in case of any pressure, RBI can use various tools to manage it. He also reiterated that liquidity will find further support from the implementation of CRR cut in a staggered manner, starting September 2025.

Limited room for further cuts

The hawkish tone of the policy statement signals limited room for further easing ahead, particularly with inflation projections for both Q4FY26 and Q1FY27 at above the 4% mark.

This is the first time RBI has maintained status quo on rates since it began the easing cycle in February 2025. The economic backdrop remains complex, and the central bank is understandably cautious given the persistent risks from global commodity prices, geopolitical tensions, and volatile capital flows. A calibrated approach while steering policies to bolster domestic growth and preparing to act if external shocks, especially tariffs, begin to weigh more heavily on recovery can be the most prudent way forward.

RBI will thus remain data dependent, closely tracking the evolving developments, especially on external front. And we could see another rate cut as and when growth-inflation dynamics change. This, however, does not seem to be the base case for MPC for now.

(Rajni Thakur is Chief Economist, L&T Finance Ltd.)

Views are personal and do not represent the stand of this organisation.