RBI’s forward guidance stays dovish, but offers no clear signal of a February rate cut

RBI Monetary Policy Review

First on the action taken at Friday’s policy. Contrary to our expectations, RBI cut the policy repo rate by 25 bps to 5.25 percent and kept the stance unchanged at “neutral”. Guidance on inflation was dovish as it reduced its inflation forecast for FY26 further by 60 bps to 2.0 percent. RBI preferred to use the space opened by low inflation to cut policy rates further.

As was being desired by the bond market participants, and to ensure transmission, the RBI also acted pre-emptively on the liquidity front by announcing Rs 1 trillion of OMO (open market operation) purchases and a $5 billion (approx. Rs 45,000 crore) buy-sell swap for December.

Inflation has largely undershot forecasts with Headline CPI inflation at 0.25 percent for October as food prices, especially vegetables, remained contained alongside favourable base effects and GST cuts. Acknowledging the same, RBI has once more revised down its inflation forecast by 60 bps to 2.0 percent for FY2,6 while the forecasts for Q1FY27 are lowered to 3.9 percent from 4.5 percent earlier.

Yes Bank forecasts are even softer, with average inflation for FY26 at 1.8 percent and Q1FY27 at 3.0 percent. As a forward-looking guidance, the RBI indicated that both the Headline and the Core retail inflation are expected to remain anchored at the 4 percent levels in H1FY27.

The RBI also expressed confidence in the future trajectory of India’s growth performance. The high-frequency indicators have held up well in Q3, on the back of GST cuts and policy accommodation. Rural sales of PVs, 2-Wheeler sales, and air traffic growth were all seen to be doing well in the data that is available for October.

Importantly, MNREGA demand for jobs is also low, indicating that rural workers are finding work beyond the agriculture sector and the MNREGA work. With food prices low, the real wages of the rural segment have also been boosted, thereby leading to rural demand outdoing urban demand.

With credit growth on the rise and with capacity utilization high, the RBI finds some indications of private investments gaining ground. The assessment of the RBI is that the external uncertainties can pose some risks to growth, but with domestic growth chugging along well, the overall growth prospects are better. This is adequately acknowledged with a 50-bps increase in the growth estimate for FY26 to 7.3 percent from 6.8 percent earlier.

More than the rate cut measure, the liquidity measures of the RBI are expected to boost credit growth and ensure the transmission of monetary policy. While RBI had been performing OMO purchases in the secondary market, the markets had been looking forward to an OMO calendar for better visibility of liquidity, and the RBI has obliged. For clarity, the RBI indicated that the OMO operation is purely a liquidity tool and is not to be construed as a yield signal.

OMO purchases by the RBI for December are at Rs 1 trillion (lakh crore). Further, the RBI announced a $5 billion buy-sell swap in December, implying that the total liquidity infusion into the system in December alone would be around Rs 1.5 trillion. While this measure, on one hand, provides comfort to the bond market with the RBI stepping in with incremental demand for Government securities, it also empowers the RBI to contain further volatilities in the USD/INR as needed.

There is also clarity from the RBI that the operative rate for the system will be the Weighted Average Call Rate (WACR), and the RBI will continue with its daily liquidity management to ensure that the WACR hugs the repo rate.

The forward guidance remains dovish, but this is no sure-shot indication of a rate cut in February. We, in fact, argue that the floor for the repo rate in this cycle has already been hit. This is because the guidance for H1FY27 Headline CPI is at 4 percent, and with the current repo rate at 5.25 percent, the real gap is low at 1.25 percent.

RBI will also have to remain mindful of the interest differential between the US and India, as a large redemption pressure of G-secs in FY27 will need the government to borrow a much larger amount from the markets than in the current year. And a higher gap will be needed to ensure participation of the FPIs in India’s G-sec issuances. A new inflation and GDP series will come out in February 2026 and the RBI should be taking cognizance of the same before taking any incremental easing step.

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