While the Monetary Policy Committee (MPC) was widely expected to leave the policy rate and stance unchanged, its distinctly dovish tone was unanticipated. Nor had the bond market pencilled in a 10-basis-point (bps) reduction in the Reserve Bank of India’s (RBI) inflation forecast for FY27, to 5%. The 10-bps increase in its GDP growth forecast, to 6.7%, had been more widely anticipated.
Although the central bank’s projections show headline inflation remaining above 5% from September through June 2027, its reluctance to raise rates appears to rest on the assessment that the pressure is being driven largely by food, fuel, and other supply-side factors.
There are few signs yet that price pressures are becoming broad-based, allowing the RBI, for the moment, to look through the increase. Headline inflation averaged 3.9% in the June quarter, 30 bps below the RBI’s forecast. It is projected to peak at 5.9% in the third quarter before tapering off.
Governor Sanjay Malhotra emphasised that core inflation remained benign; its FY27 forecast has been lowered by 40 bps. He also observed that while the objective was to bring inflation down to 4%, this was a medium-term goal. The RBI, therefore, appears unwilling to disrupt the growth momentum in a year when El Niño could hurt agricultural output.
After all, even at the revised forecast of 6.7%, GDP growth is expected to decelerate this year and could do with policy support. There is also little merit in driving up bond yields, which have settled in the 6.7-6.8% range. Lower yields benefit all borrowers, including the government; the benchmark yield eased to 6.77% on Wednesday.
The RBI is, therefore, justified in sounding somewhat less cautious than expected. Its neutral stance gives it sufficient flexibility to respond in either direction as the inflation-growth balance evolves, without committing it prematurely to a rate increase. It also leaves the central bank room to act if crude oil prices surge again, domestic pump prices are raised, or food inflation proves more persistent than projected.
Meanwhile, the strong response to the foreign currency non-resident (bank) [FCNR(B)] scheme, which has attracted around $36 billion so far, has eased pressure on the rupee and reduced the immediate need for a rate increase. The governor’s expectation of a balance-of-payments surplus this financial year also signals confidence in capital flows.
The chances of a rate hike in October, therefore, appear limited unless adverse domestic or global developments force the MPC’s hand. The central bank will watch the US Federal Reserve’s guidance for clues about the India-US interest-rate differential, as well as the rupee’s movement after the FCNR(B) window closes on September 30.
Economists now expect a rate increase either in December or early next year. By then, the second-order effects of higher input costs may have begun to show. Corporate commentary suggests that companies have raised prices to pass on higher costs, but a complete pass-through is yet to happen.
The impact of El Niño on agricultural output and food prices should also be clearer. The current consensus is for cumulative tightening of about 50 bps. Importantly, Malhotra observed that while liquidity could improve in the near term, a large surplus should not be expected beyond September.
Given its evident concern about growth, however, the RBI is likely to ensure that liquidity remains adequate even as it keeps the option of a future rate increase open.