RBI signals long pause

The decision, in line with the overwhelming majority of forecasts, sets India apart from regional peers such as Indonesia, the Philippines, Japan and Australia, which have tightened policy in response to war-driven energy costs and currency volatility. The RBI has instead chosen to treat the conflict as a temporary supply shock — to be answered with rate action only if higher energy costs spill into broad-based inflation — while deploying capital-flow measures to defend the rupee.

“We are neither dovish nor are we hawkish. We feel that this is the right policy rate for the given growth-inflation dynamics that we are in today,” RBI Governor Sanjay Malhotra said at the post-policy press conference.

The dovish tone of the policy has firmed up a consensus among bankers and economists that the repo rate will stay on pause at the October review, with some predicting status quo through the remainder of the fiscal year.

“No hawks in sight as RBI keeps rates unchanged while lowering its inflation and raising its growth forecast for FY27,” says Pranjul Bhandari, chief India economist at HSBC Global Investment Research.

The RBI cut its inflation forecast for FY27 to 5% from 5.1% earlier, pared its core inflation projection more sharply to 4.3% from 4.7%, and nudged up its GDP growth estimate to 6.7% from 6.6%. For the first quarter of FY28, the central bank pegs inflation at 5.3% and GDP growth at 7.3%.

Despite global headwinds and the El Nino impact on an uneven monsoon, Malhotra’s reluctance to kickstart a rate-hike cycle springs from optimism that domestic economic activity is “resilient” and that the first quarter has seen steady growth — even as manufacturing PMI has slipped to a five-year low, bank credit continues to expand at nearly 18%. The RBI’s series of measures to attract dollars, including the swap facility for FCNR(B) deposits, is seeing “robust inflows” — over $41 billion has come in since the June measures — and growth, the central bank believes, will “absorb liquidity” while bolstering the balance of payments and the rupee.

Two other factors worked in favour of the pause. The US Federal Reserve recently held rates steady. And crude oil, which had boiled to $100 a barrel on July 23 when the US restarted air strikes on Iran, has since cooled to around $80, with a ceasefire — however shaky — holding between the US and Iran.

The worry on inflation persists, and, as Malhotra put it, the central bank’s “target is headline inflation” and “it will continue to be guided by that”. In June, retail inflation crossed the RBI’s medium-term target of 4% for the first time in 17 months, at 4.38%. The RBI expects it to climb further and peak at 5.9% in the fiscal third quarter before moderating — but to stay within the 2-6% tolerance band through the year, giving policymakers breathing room.

The central bank also drew comfort from the composition of the price rise: inflation is not getting broad-based and is primarily led by food and fuel, while core inflation remains moderate — and, excluding precious metals, even lower.

State Bank of India managing director Ashwini Kumar Tewari believes a rate hike is most unlikely. “Going by the RBI views and the macroeconomic position, rate hike doesn’t look likely. At least, not this year. FCNR(B) flows will also help bring in liquidity and support the loan growth which continues to be strong,” he said.

Geopolitical uncertainty could yet send oil back above $100 a barrel — India imports roughly 90% of its crude needs — but the MPC chose to wait and watch before contemplating a hike. “There is a need for greater clarity to emerge, especially regarding inflation, its path and composition before taking any policy action,” the RBI said.

The central bank has also found comfort in growth being supported by strong domestic demand and frontloading of manufacturing by producers. Policymakers will get two key data points before the October review: July inflation next Wednesday, and first-quarter GDP on August 31, after growth accelerated to 7.8% in the January-March quarter.

“The upward revision to GDP growth forecasts reinforces the limited impact to Indian economy from external shocks and augurs well for bank credit growth and profitability. Ample liquidity due to FCNR(B) flows will further catalyse credit growth in the banking system. Bond yields may also show some stability taking a cue from inflation forecasts,” said Brajesh Kumar Singh, managing director and CEO, Canara Bank.

“We see limited scope for a rate hike at the October meeting, consistent with our baseline expectation that policy rates remain unchanged through the rest of FY27. The MPC appears comfortable remaining on hold for now, given the absence of broad-based inflation pressures and lingering uncertainty around the inflation outlook,” said Radhika Rao, senior economist and executive director at DBS Bank.

That view is not shared by Bhandari. “We continue to forecast rate hikes in this calendar year of 50 basis points overall. We believe it may become important for financial stability with domestic real interest rates dipping into the negative, and we also have an eye on the yield and interest rate differential between the US and India. We think this could become an important consideration after the NRI deposit window closes in end-September,” she said.

The risks to the sanguine inflation view are not trivial. The finance ministry warned last week that price pressures were broadening beyond food, and large consumer goods companies are preparing a second consecutive round of price increases to pass on higher input costs. Rainfall remains deficient in parts of the country, and sowing of key crops, including rice and pulses, continues to lag last year’s levels — with food the largest component of the consumer price index.

Markets read the policy as dovish. The 10-year government security yield eased 4.5 basis points to close at 6.77%, with the rally sharper at the short end — five-year yields fell about 8 basis points — as Malhotra gave no indication of any liquidity absorption measures. Ample liquidity, with the banking system flush with a surplus of over Rs 3 lakh crore, is expected to pull yields down further.

“The market expected a slightly hawkish stand, but the policy was dovish and there was no move to suck out excess liquidity. The RBI Governor said that most of the liquidity from the FCNR(B) inflows will be utilised. The GDP will weigh more on the interest rate cycle,” said Alok Singh, head of treasury at CSB Bank.

On FCNR(B), Malhotra said most of the flows will be utilised and liquidity will be available for a short while.

The rupee ended at its highest level in a month on Wednesday at 95.12, its strongest closing level since July 7, after having opened 0.5% higher at 94.92 per US dollar.

On the exchange rate, Malhotra reiterated that the RBI does not target any specific level and will continue to let market forces determine the currency’s value, stepping in only to prevent excessive volatility.

“There can be an argument, as some people have made, that perhaps nominal effective exchange rate terms may be undervalued. There is a lot of uncertainty. It is quite possible going forward, as the tensions and the conflict de-escalate, that the Indian currency will get further strengthened,” Malhotra said, noting that the rupee’s nominal effective exchange rate (NEER) has strengthened from around 97 per dollar to 95 over the past month.