On December 5, the Reserve Bank of India (RBI) finished its monetary policy in the face of conflicting market opinions and a very complicated collection of facts.
The RBI hit a bold hook shot for a boundary with a 25-bps rate reduction since the field was tight and bowlers were waiting for an edge.
RBI Cuts Policy Rate
The MPC unanimously decided to lower the policy rate to 5.25 percent. Consequently, the standing deposit facility (SDF) rate remained at 5.00 percent under the liquidity adjustment facility (LAF), while the bank rate and the marginal standing facility (MSF) rate stayed at 5.50 percent. Furthermore, the MPC maintained its neutral posture by a vote of 5:1, with one external member supporting a shift to accommodating.
In Q2FY26, real GDP growth reached an 18-month high of 8.20 percent. Furthermore, although few leading indicators are indicating a slowdown, high frequency indicators indicate that domestic economic activity is robust for Q3FY26. Additionally, according to the first advance estimate, the output of kharif crops is anticipated to be greater in FY26 than in FY25.
RBI Projects Steady Growth
The uncertainty surrounding the US-India trade agreement and other external shocks continue to be a negative factor on development. In light of these variables, the RBI has projected the following real GDP growth: FY26: 7.30 percent (6.80 percent); Q3FY26: 7.00 percent (6.40 percent); Q4FY26: 6.50 percent (6.20 percent); Q1FY27: 6.70 percent (6.40 percent); Q2FY27: 6.80 percent with equally distributed risks.
October 2025 had the lowest headline inflation in the CPI series, at 0.25 percent. Deflated food costs are the main cause of this. Due to increased metal costs, core inflation has exceeded 4%. However, the World Bank Commodity Price Forecasts predict that future international commodity prices would largely decline, with the exception of a few metals. The inflation estimates, taking into account all the variables, are as follows: FY26: 2.00 percent (2.60 percent); Q3FY26: 0.60 percent (1.80 percent); Q4FY26: 2.90 percent (4.00 percent); Q1FY27: 3.90 percent (4.50 percent); Q2FY27: 4.00 percent with equally distributed risks.
RBI Boosts System Liquidity
Since the RBI’s most recent October 2025 policy, system liquidity has stayed at an average of Rs 1.5 lakh crore. The RBI has also taken action to increase the amount of liquidity in the banking sector by purchasing Rs 1 lakh crore via OMO (Open Market Operations) in two installments of Rs 50,000 crore on December 11 and December 18. The RBI will also engage in a $5 billion, three-year buy-sell exchange between USD and INR on December 16.
The governor emphasized the need of preserving benign inflation and guaranteeing efficient monetary policy transmission at the post-policy news conference. He emphasized that the banking system’s excess liquidity is necessary for transmission to enter the actual economy. The Governor restated the RBI’s commitment to provide the banking sector enough, long-term liquidity.
RBI Avoids Rupee Targeting
“Our focus has always been to minimize any undue volatility in the FX market,” the Governor said, clarifying that the RBI does not aim for a certain rupee level. We just let the rupee to establish its proper level and position.
Bond markets applauded Friday’s 25 basis point reduction, with the 10-year G-sec yield falling 3 basis points to around 6.48 percent. We anticipate further announcements of OMO purchases in the first quarter of Q4FY26, given the general view on the liquidity of the banking sector and the Governor’s promise to provide permanent liquidity.
The threshold for further rate cuts in this cycle is somewhat higher due to the 25 basis point reduction in December 2025, and this will depend on future growth-inflation dynamics. Nevertheless, the difference between 10-year G-sec and repo is around 120 bps, which is more than the average of 105 bps during the previous ten years. We anticipate a lengthy break in this cycle, similar to a hitter deciding not to swing at every pitch after discovering the boundary early in the test innings. Overall, the policy was well-balanced.
