First, let us talk about Friday’s policy. In contrast to what we anticipated, the RBI maintained its “neutral” position while lowering the policy repo rate by 25 basis points to 5.25 percent.
RBI Eases Inflation Outlook
It also lowered its inflation prediction for FY26 by 60 basis points to 2.0 percent, which was dovish guidance on inflation. The RBI chose to further reduce policy rates by taking advantage of the room created by low inflation.
The RBI also took proactive measures on the liquidity front by announcing Rs 1 trillion in OMO (open market operation) purchases and a $5 billion (about Rs 45,000 crore) buy-sell swap for December, as requested by bond market players and to guarantee transmission.
Inflation Falls Below Expectations
With headline CPI inflation of 0.25 percent for October, inflation has significantly underperformed projections due to favorable base effects, GST reductions, and the containment of food costs, particularly those of vegetables. Recognizing this, the RBI has once again reduced its inflation projection by 60 basis points to 2.0 percent for FY2.6, while the forecasts for Q1FY27 have been decreased from 4.5 percent to 3.9 percent.
With an average inflation rate of 1.8 percent for FY26 and 3.0 percent for Q1FY27, Yes Bank’s projections are significantly weaker. Both Headline and Core retail inflation are anticipated to be anchored around the 4 percent levels in H1FY27, according to the RBI’s forward-looking outlook.
Additionally, the RBI voiced optimism about India’s economic potential going forward. Thanks to GST reductions and policy accommodations, the high-frequency indicators performed strongly in Q3. The statistics available for October showed that air traffic growth, 2-wheeler sales, and PV sales in rural areas were all performing well.
Rural Demand Strengthens Further
Significantly, there is little demand for jobs under MNREGA, suggesting that rural people are finding employment outside of agriculture and MNREGA. Because food costs are low, the rural segment’s actual incomes have also increased, which has caused rural demand to surpass urban demand.
The RBI observes certain signs of private investments gaining traction due to rising loan growth and strong capacity utilization. The RBI believes that although there may be some risks to growth from external uncertainty, overall growth prospects are improved due to the strong domestic growth. The growth projection for FY26 has increased by 50 basis points to 7.3 percent from 6.8 percent, which is a sufficient acknowledgement of this.
RBI Boosts System Liquidity
The RBI’s liquidity measures are anticipated to increase credit growth and guarantee the transmission of monetary policy more than the rate lowering measure. Although the RBI had been making OMO purchases in the secondary market, the markets had been anticipating an OMO calendar to improve liquidity visibility, and the RBI complied. To be clear, the RBI said that the OMO operation is not a yield signal and is just a liquidity instrument.
The RBI spent Rs 1 trillion (lakh crore) on OMO purchases in December. Additionally, the RBI announced a $5 billion buy-sell swap in December, suggesting that the economy will receive almost Rs 1.5 trillion in liquidity in December alone. On the one hand, this action reassures the bond market by allowing the RBI to step in and increase demand for government assets, but it also gives the RBI the authority to limit future fluctuations in the USD/INR when necessary.
Further Rate Cuts Uncertain
The RBI has also made it clear that the Weighted Average Call Rate (WACR) would remain the system’s operational rate. The RBI will continue to manage its daily liquidity to make sure the WACR is close to the repo rate.
Although the forward guidance is still dovish, a rate decrease in February is not certain. In fact, we contend that this cycle’s floor for the repo rate has already occurred. This is due to the fact that the actual gap is just 1.25 percent given the current repo rate of 5.25 percent and the projection for H1FY27 Headline CPI of 4 percent.
A significant redemption pressure of G-secs in FY27 would need the government to borrow a much higher amount from the markets than in the present year, therefore RBI will also need to be aware of the rate disparity between the US and India. Additionally, a larger gap would be required to guarantee FPIs’ involvement in India’s G-sec issuances. The RBI should be aware of the upcoming release of a fresh GDP and inflation figures in February 2026 before implementing any more easing measures.
