Introduction to India’s Monetary Policy
The RBI’s Monetary Policy Committee (MPC) has decided to leave the policy rate unchanged and maintain a neutral stance. This decision is in line with expectations and is based on the central bank’s assessment of the current economic situation. The sharp decline in inflation is attributed to volatile food prices, specifically vegetable prices. However, the RBI has cautioned that with the low base of this year, CPI inflation is projected to rise above 4 per cent and beyond in 2026.
Current Inflation Scenario
CPI inflation fell sharply to around 2 per cent in June 2025 and is estimated to remain benign at around 2.5 per cent in the next two quarters. The RBI has lowered the CPI projection for FY26 to 3.1 per cent due to the sharper-than-expected fall in inflation. Vegetable inflation, which was very high in 2024, has recorded sharp deflation, averaging -15 per cent in the last three months. If we exclude vegetable prices, CPI inflation was in the range of 3-4 per cent for the entire FY25 and remains in the same range in Q1 FY26.
Factors Contributing to Low Inflation
Apart from vegetables, many other components of the food basket are also seeing low inflation or deflation, supported by a good monsoon and a high base from last year. The point to note is that a large part of the fall in inflation is because of the statistical base effect. However, next year, we will see inflation rising again as the base effect reverses. It is expected that CPI inflation will breach the 4 per cent level in Q4 FY26 and average more than 4.5 per cent in FY27 — this is broadly in line with the RBI’s projections.
Growth Projections
As far as growth is concerned, the RBI remains optimistic and has maintained the GDP growth projection for FY26 at 6.5 per cent. Factors like recent interest rate cuts, strong agricultural activity boosting rural demand, benign inflationary conditions, favourable monsoon, and lower income tax burden are supportive of growth this year. While the recently announced higher reciprocal tariff by the US has raised some growth concerns, it should be noted that India is a domestic demand-driven economy, and merchandise exports to the US contribute only around 2 per cent to our GDP.
Domestic Concerns
On the domestic front, there are some concerns around consumption and investment recovery not being broad-based. While a healthy monsoon has supported rural demand, subdued income growth in urban areas is concerning. This becomes specifically critical amidst weak hiring in the IT sector. The subdued household income growth is also getting reflected in weaker consumption growth, specifically in urban areas. On the investment front, the Centre’s push to capex has continued with a growth of 52 per cent recorded in Q1 FY26. However, private players remain cautious in the midst of economic uncertainties.
External Sector
India’s external sector will continue to face uncertainties given the risk posed by the US’s reciprocal tariff. The benefit that India had vis-à-vis some of the other Asian peers has been reversed, with India now facing a higher tariff. It is expected that India’s merchandise exports will contract in FY26. However, services exports will remain healthy, albeit with some moderation in growth. Overall, it is expected that India’s current account deficit will be manageable at 0.9 per cent of GDP in FY26. However, capital flows could remain volatile in the midst of aggravated global uncertainties.
Future Expectations
What should we expect going forward? The RBI had already cut the policy rate by 100 bps since February 2025 and taken measures to ensure ample liquidity in the system to facilitate rate transmission. Hence, the central bank would now like to wait and watch to see the impact of further transmission. Moreover, with average CPI inflation expected to be around 4.5 per cent or even more in 2026, we are already talking about a very low real interest rate of around 1 per cent. With growth momentum likely to be maintained at around 6.5 per cent, there is no need for further rate cuts. Only if the growth trajectory gets severely dented by the aggravation of trade risks can we expect a further rate cut by the central bank in this cycle.
Conclusion
In conclusion, the RBI’s decision to leave the policy rate unchanged is based on the current economic situation and the expected rise in inflation in the future. While there are concerns around consumption and investment recovery, the growth momentum is expected to be maintained at around 6.5 per cent. The external sector will continue to face uncertainties, but the current account deficit is expected to be manageable. Overall, it is expected that India will manage a healthy growth in FY26, despite the challenges posed by the US’s reciprocal tariff and other global uncertainties.
