The RBI’s December MPC meeting is shaping up to be a test of biases amid conflicting economic signals. With hard data offering contrasting cues, the discussion is likely to lean more on the art of policymaking than the science. The October policy explicitly highlighted the opening up of policy space to support growth—a stance reiterated in subsequent communications.
It’s prudent to lower policy rate
The MPC’s challenge will be to weigh strong real GDP growth prints against relatively weak nominal growth, alongside inflation running below the RBI’s lower bound of the 2–6% target range and tracking close to the 4% central target over the next 12 months. While the decision will be finely balanced, a 25 basis points cut in the repo rate appears prudent.
Forward guidance should retain a mildly dovish tone to ensure transmission to market rates and provide a buffer against uncertainties.
Six factors that need to be considered
The discussion on rate action will rest on few key pillars: (1) inflation which is expected to be within the RBI’s comfort zone, (2) mixed signals from GDP growth, (3) risks to the external balance and INR movements, (4) extent of transmission of past rate actions, (5) durable liquidity and its implications for market rates and financial system, and (6) risks from geopolitical and trade uncertainties.
Prudent policy demands that one tool addresses one target. Essentially, the MPC needs to focus on inflation-growth dynamics while the RBI deploys its broader toolkit to address equally important issues on liquidity and exchange rate management.
Inflation: Not a concern, for now
Successive downside surprises in inflation have caught both RBI and markets off guard. Between the February and October policies, RBI’s FY2026 inflation estimate was cut by 200 basis points from 4.6% to 2.6%. The December policy could see another 30–40 basis points reduction. Market forecasts too have mirrored this trend. Core-core inflation (core excluding gold) has fallen to around 2.5% in October; underscoring the underlying benign price pressures in the economy.
RBI’s focus has also been on the FY2027 trajectory. We estimate a downside of around 50 basis points to RBI’s 1QFY27 estimate of 4.5%. Our estimate for average inflation in FY2026-27 is around 2% and 4% with most of the upside driven by lower base. Admittedly, much of the inflation trajectory has benefited from favorable base effects and benign food prices. While short-cycle crop price spikes remain unpredictable, durable shocks from staples like rice and wheat seem unlikely given production levels and buffer stocks. A degree of caution is warranted, but probabilities favor a benign outlook.
Growth: A mixed story
India’s FY2026 growth narrative is quite contrasting. Real GDP surged 8% in the first half, powered by low deflator, with nominal GDP growth lagging at 8.8%, below its decade-long average of just over 10%. Weak nominal growth poses headwinds for corporate earnings, tax collections, and debt servicing. Hence, any growth discussion must weigh both real and nominal dynamics, especially in the backdrop of exceptionally low GDP deflators.
Economic activity has benefited from monetary policy easing, government spending, and inflation moderation. More recently, pent-up demand post-GST implementation and festive demand have buoyed discretionary consumption. Sustaining this momentum, however, will be challenging. Pace of central government spending may need to be tapered given tax slippages and front-loading of spending. Rural economy which has fared better than urban will run the risk of adverse terms of trade for farmers if food price inflation remains depressed for long.
While real GDP growth in FY2026 is likely to be around 7.8%, we forecast growth in FY2027 to be around 6.5% driven by higher deflator even as support from favorable fiscal and monetary policies continues. The RBI will have to revise up its FY2026 growth estimates from 6.8% currently while possibly maintaining its FY2027 outlook.
Liquidity: The other half of the equation
While rate action dominates headlines, liquidity remains equally critical. Transmission has been efficient owing to easy liquidity in 1HFY26. However, recent FX interventions have tightened durable liquidity, with system liquidity dropping to around 0.5% of NDTL from around 2% for most part of 1HFY26.
Even after the CRR cuts, there is a need for around Rs1.5 trillion of durable liquidity injection (likely via OMO purchases) in the rest of FY2026. While liquidity announcements need not have to be part of the monetary policy, they should follow soon to sustain policy transmission. RBI’s decisions in the December policy (and/or after) will need to address both the cost of liquidity and the quantum of liquidity to ensure addressing its growth objective, till the time price pressures remain benign.
(Suvodeep Rakshit, is Chief Economist, Kotak Institutional Equites.)
Views are personal, and do not represent the stance of this publication.
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