By Indranil Pan, Chief Economist at Yes Bank
The RBI turned dovish in this policy meeting. The rate cut was a foregone conclusion, and a 25 bps was delivered. What makes this policy statement dovish is the change in stance from “neutral” to “accommodative”. An accommodative stance was explained as a zero chance of any rate increase. And, with the commentary on inflation being on the dovish side, it opens room for more repo rate reductions than was earlier anticipated.
There is growing confidence in inflation trends going forward. After significant efforts – with policy rates having stayed tight for as long as 24 months, inflation is finally showing signs of aligning itself to the target levels of 4%. Helping the inflation trend is the vegetable prices that have now degrown on a sequential basis over the last four consecutive months. For February, inflation reading was lower-than-expected at 3.6% and we expect similar figures for March, given that National Horticulture Board (NHB) data shows a further ~2% decline in vegetable prices for March.
What provides confidence to the inflation trajectory is the good rabi crops – a record wheat production and higher pulses production from the last year. Buffer stocks also remain comfortable. In the March 2025 round of household inflation expectations survey, the 3-month and 1-year inflation expectations have dropped by 40 and 50 bps respectively over the previous survey, thereby providing more confidence in the inflation outturn in the months ahead.
While there could be some fears of currency (INR) depreciation and supply chain distortions to lead to inflationary pressures, currently the markets are pricing in a bigger probability of global slowdown, and a recession in the US. China’s economic momentum could also be anticipated to weaken too under the pressure of a 100%+ tariff. This has led to a slump in Brent crude prices and the prices of industrial metals, that bode well for India’s inflation. Overall, the inflation projection by the RBI was reduced to 4% for FY26, from an earlier 4.2%. Yes Bank estimates are lower in the range of 3.5-3.7%, assuming no ugly summer season vegetable price shock and normal monsoons.
With inflation being anchored to the 4% line on a durable basis, monetary policy finds the opportunity to turn to address growth issues. While there could be a direct implication of the tariffs imposed on India impacting exports to the US, the hit to exports could be larger as the whole globe slows under the pressure of tariffs.
Overall, the understanding of the monetary policy authorities is that tariffs could hurt India’s growth in a bigger way than it can create inflationary pressures. The statement today makes it clear that while growth is improving, the global uncertainties and volatilities are likely to lead to relative growth underperformance. Having said, domestic growth could be buffered to an extent by agricultural growth and hence better prospects for rural consumption. Income tax cuts and rate cuts by the RBI will also favour domestic growth. RBI has reduced its growth forecast for FY26 from 6.7% to 6.5% (equivalent to Yes Bank’s growth estimates).
Given that the RBI has now turned its stance to “accommodative”, the question to ask is how many rate cuts can be expected in this cycle. Given RBI’s inflation forecasts of 4% for FY26, and assuming a real rate of 1.5%, the terminal repo rate in this cycle could be at around 5.50%, implying another 50-bps rate cut in this cycle – to be delivered in June and August. However, if the growth concerns were to deepen, and inflation trends remain manageable, the RBI could even get comfortable with a real rate of 1%, implying a terminal rate of 5%, thereby opening space for repo rate reduction of an incremental of 100 bps from the current 6.0%. However, given significant uncertainties that exist in the global economic environment, deciding for such a long way out into the future becomes difficult. The rate cuts of June and August are more visible now and beyond that the growth-inflation mix that evolves for the domestic economy will determine further action.
In the meanwhile, focus for the RBI would squarely be on ensuring transmission of the policy rate cuts of February and April. RBI had remained front-footed on providing liquidity to the system and today the banking sector liquidity is in the surplus zone. The Weighted Average Call Rate (operative rate) is also hugging the policy (signaling) rate. There were no fresh liquidity-related announcements on Wednesday, but the commitment is to provide adequate rupee liquidity and to take pro-active steps to ensure the same, much needed if the transmission of repo rates cuts were to percolate into the economy.
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