RBI signals end of rate cut cycle; MPC flags growth risks from tariffs

A consistent undershoot of inflation has forced a downward revision of inflation forecasts by the central bank from 3.7% earlier to 3.1% now

The Reserve Bank of India held repo rate at 5.5% and kept the stance unchanged at “neutral”. The communication had a hawkish tilt, that has now reduced market expectations of any further monetary policy easing in this cycle. Despite a reduction in the inflation forecast by the RBI for the current year by a sharp 60bps, there was no follow through to rates as RBI found it appropriate to wait and watch the impact of the transmission of the 100 bps into the “credit markets and the broader economy”.

The macro underpinning that led to the decision is as follows. Inflation has remained largely contained this year on account of favourable base effect as well as lower food inflation, especially vegetables. A consistent undershoot of inflation has forced a downward revision of inflation forecasts by the central bank from 3.7% earlier to 3.1% now. Inflation forecasts for the various quarters have also been revised: Q2FY26 at 2.1% (earlier 3.4%), Q3FY26 at 3.1% (earlier 3.9%) and Q4FY26 unchanged at 4.4%. Q1FY27 estimate for inflation is at an elevated 4.9%. RBI also alludes to core inflation having remained somewhat elevated – probably another reason why the RBI would not have wanted to further ease monetary policy.

The commentary on growth also indicated a steady trend path with no revisions for the current year while Q1FY27 estimates now stand at 6.6%. MPC expressed confidence in demand revival on account of supportive monetary policy as well as continued government expenditure. The service sector is expected to stay robust while industrial sector has shown some weakness as the drag on mining and electricity continues. While the MPC acknowledged risks to growth emanating from tariffs, the domestic growth looks largely stable at this point.

For now, the RBI has probably not factored in any tariff related hit to growth. US is an important market for India, accounting for nearly 20% of India’s exports. The US administration has also been targeting India, imposing additional 25% tariff on Wednesday for having continued trade links with Russia, in addition to the earlier 25% tariff.

Though this is not the end game on tariffs, and negotiations would continue, the tariff war between India and the US can potentially get into a difficult zone. India has issued a statement that while it stays committed to a mutually beneficial Bilateral Trade Agreement (BTA), it would protect the “welfare of our farmers, entrepreneurs, and MSMEs”. This is important as it expresses clearly that India is unlikely to be ready to open the domestic agricultural and dairy segments, probably the main source of disagreement between the two countries.

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Indranil Pan

Chief Economist|YES Bank

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Further, Ministry of External Affairs responding to Trump’s remarks indicated that India turned to discounted Russian oil after traditional suppliers shifted exports to Europe. And there are no indications that India would stop importing oil from Russia.

Today’s communication from RBI exhibited relatively more confidence on growth than inflation, and this was brought out by the projections. Even as the inflation forecast for FY26 was lowered by 60 bps, enhanced monetary easing was not in order. This was due to a forward-looking RBI seeing a Q1FY26 inflation expectation of 4.9%, thereby indicating a real interest rate gap of only 60 bps. Any cut now could have forced the hands of the RBI to increase interest rates sooner than later to restore the real gap at a comfortable level of 100-150 bps.

Further, the RBI remained hopeful of the economic momentum continuing, especially as rain gods have smiled favourably, leading up to an uptick in festive demand. This is also possibly a reason why the RBI tended to also look at core inflation this time, indicating that it has been rising steadily, even as one excludes precious metals from it.

While in the current uncertain economic landscape, there is nothing called a zero-probability event, we think that the bar for any further rate cuts is high, and any further easing of monetary policy could be on the back of undershoot of growth expectations, given the tariff hit on India.

Bond markets have already been pricing in no further rate cuts in the remaining of the financial year. This is reflective in the 10-year G-sec yields having moved up to 6.42% post policy from a 6.3% pre-policy. While too early to confidently indicate any risks on the fiscal side, early indicators are for a slowing revenue growth and a higher expenditure growth (especially on the capex side). A critical determinant of domestic yields would also be global yields, that have stayed relatively elevated given the high levels of sovereign debt. We expect 10-year G-sec yields to broadly remain at 6.35-6.45% in the next 6 months.

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