Policy Rates Maintained
In its recent Monetary Policy Committee meeting, the Reserve Bank of India opted to keep its key policy interest rates unchanged. This decision follows
a series of rate cuts totaling 125 basis points implemented throughout 2025. The central bank's stance is underpinned by a favorable economic growth trajectory for India and a stable inflation environment. While no new measures to inject liquidity were announced, the RBI is expected to continue its interventions to ensure sufficient funds are available in the banking system as needed. The macroeconomic indicators for India are currently signaling strong economic momentum, with advance estimates projecting a Gross Domestic Product growth of 7.4 percent for the fiscal year 2026.
Trade Deal Boosts Outlook
The nation's economic outlook has seen an upward revision, partly due to an improved India-US trade relationship. Previously, Indian exporters faced challenges from US tariffs, which impacted non-petroleum goods exports negatively by 2.2 percent between September and November 2025. Key sectors like gems and jewellery, ready-made garments, textiles, and chemicals were particularly affected. Although some export diversification occurred, the overall growth of non-petroleum goods exports moderated to 3.5 percent in the September-November period, down from 7.3 percent in April-August 2025. With exports to the US constituting approximately 20 percent of India’s total exports, the reduction in tariffs is anticipated to provide significant relief to exporters. Initial analyses suggest this tariff adjustment could boost GDP growth by around 0.2 percentage points, potentially raising the FY27 growth projection to 7.2 percent, although final figures await the release of the new GDP series. The RBI itself has expressed optimism, revising its first-half growth forecast upwards by 20 basis points.
Inflation Comfortably Low
Inflationary pressures in India remain under control, with the fourth quarter of fiscal year 2026 estimated to see inflation around 3.2 percent. Core inflation, excluding the impact of gold price fluctuations, was also notably low at approximately 2.6 percent as of December 2025. Assuming consistent weather patterns, the inflation rate is projected to remain at a comfortable 4 percent for fiscal year 2027. However, the central bank will monitor the impact of the new Consumer Price Index (CPI) series before finalizing its inflation projections for FY27. Despite the RBI's efforts to manage liquidity, the average banking system liquidity has decreased to Rs 0.7 trillion over the last two months, compared to an average of Rs 2 trillion from April to November 2025. Part of this liquidity tightness can be attributed to the RBI's foreign exchange interventions. Nevertheless, the expectation is that the need for such interventions might lessen as the signing of the trade deal with the US is likely to bolster support for the Indian rupee.
Bond Yield Pressures
Government Securities (G-Sec) yields have experienced an increase of 45 basis points over the past eight months, even with the policy rate cuts. This has widened the spread between the 10-year G-Sec yield and the repo rate to a substantial 150 basis points. The significant gross borrowing requirements for the Centre in FY27 are contributing to this pressure on G-Sec yields. The situation is further exacerbated by substantial borrowings from state governments. The spread on 10-year state government bonds over G-Secs has widened considerably, reaching 70 basis points, up from 35 basis points at the start of the fiscal year. To address the demand-supply imbalance in the government bond market, the central bank might consider conducting Open Market Operations (OMO) purchases. Looking ahead, the RBI is expected to maintain its status quo on policy rates, recognizing the uncertain and volatile global economic landscape. By preserving its policy ammunition, the RBI can strategically deploy it if future circumstances necessitate. With an anticipated improvement in credit demand, the focus will remain on ensuring adequate liquidity and supporting government bond yields.
