RBI holds rates as inflation caution meets fiscal reality

The Reserve Bank of India’s Monetary Policy Committee (MPC) opted to keep its benchmark repo rate unchanged at 5.25% on Friday, marking a strategic pause in the sixth and final monetary policy review for FY2026. 

Addressing the media from the central bank’s headquarters, governor Sanjay Malhotra opened with a confident assessment, stating that the Indian economy is currently “in a good spot” despite a global landscape where uncertainties remainelevated; this is a reiteration of the Goldilocks scenario. The governor noted that underlying data points to a “strong growth momentum”, with domestic demand and activity indicators continuing to defy the gravity of external headwinds. 

The RBI kept repo rate unchanged at 5.25%

Friday’s announcement followed two key developments—the FY2027 Budget and recent trade pacts with the European Union and the US. Against this backdrop, the RBI governor’s address emphasised the structural support from shifting trade alliances, explicitly linking these agreements to the sustainability of India’s growth trajectory. 

The central bank appears to be betting that these agreements—which have slashed tariffs and opened new corridors for Indian manufacturing and exports—will act as a growth engine for the economy, allowing the RBI to step back from further monetary easing. By maintaining its “neutral” stance, the RBI is signalling a period of watchful waiting as it assesses the lagging impact of previous rate cuts and the evolving domestic landscape. 

While the growth narrative remains robust, the MPC struck a hawkish note on prices. The committee sharply raised its inflation forecasts for the first half of FY2027 to 4% for Q1 and 4.2% for Q2. While these figures remain within the RBI’s 4%+/-2% tolerance band, they represent a marginal uptick from the 3.9% and 4% projections made in the last MPC meet in December 2025. 

The MPC’s upward revision of inflation signals a shift from the central bank’s earlier expectations of a more rapid disinflationary path. While headline inflation remains below the tolerance band and close to target, the RBI flagged that the higher near-term projections are driven largely by rising precious metals prices—accounting for around 60–70 basis points—rather than a broad-based pickup in underlying pressures.  

This is crucial. Super-core inflation—CPI excluding food, fuel, gold, and silver—stood at 2.36% in December 2025. With the repo rate held at 5.25%, the economy is effectively operating with a real rate of around 2.9%, an elevated level relative to underlying inflation. This helps explain why the RBI is comfortable pausing despite higher headline projections, focusing instead on liquidity management and awaiting greater clarity from the forthcoming 2024-base CPI series. 

With super-core inflation at 2.36% and repo rate at 5.25%, the economy is effectively operating with a real rate of around 2.9% 

One structural constraint sits beneath the MPC’s inflation signalling: timing. The committee meets once every two months, typically in the first week of that month, while official consumer price inflation data is released only around the 12th of each month. As a result, policy decisions are taken without visibility on the most recent inflation print, forcing the MPC to rely on partial information and forecasts at precisely the moment when marginal shifts in inflation matter most. 

As the MPC turns more cautious on FY2027 inflation, this misalignment between the policy calendar and the inflation reporting cycle becomes harder to ignore. This is where Thurro’s inflation NowCast becomes analytically useful—bridging the information gap between policy decisions and official inflation releases. 

Food and beverage inflation is among the most volatile components of India’s consumer price index. Prices are seasonal, geographically fragmented, and prone to sudden shocks. Despite this, Thurro’s food and beverage inflation NowCasttracked official MOSPI prints closely through 2024 and 2025, including periods of sharp inflation, rapid disinflation, and brief deflationary episodes. 

Thurro’s food and beverage inflation NowCast tracked official MOSPI prints closely through 2024 and 2025 

Most notably, the NowCast was available 10–12 days before the official release. Across months, the model proved to be highly precise—capturing both the peak in late 2024 and the steady cooling that followed into mid-2025. 

The RBI’s decision to hold rates comes against a bond market that is already signalling limited room for further monetary action. Usually, when the RBI cuts interest rates, the interest rates on government bonds (yields) follows – though as we know, the lags of monetary policy are variable and uncertain.  

Despite cumulative policy easing of 125 basis points over the past year, the 10-year government bond yield remained broadly anchored in the 6.4–6.6% range through much of 2025. Even after the RBI cut the repo rate by 25 basis points in December, yields rose nine basis points to 6.74%. 

As a result, the gap between the policy rate and the benchmark sovereign yield has widened to around 150 basis points—elevated by recent standards and persistent despite repeated policy action. 

The gap between the policy rate and the benchmark sovereign yield now stands at roughly 150 basis points 

Such a divergence is rare, though not unprecedented. Since January 2016, the gap exceeded 140 basis points on only five occasions before September 2019. It widened sharply thereafter, peaking between 2019 and November 2022, when pandemic-era borrowing and liquidity pressures overwhelmed conventional rate signalling. 

The re-emergence of a wide gap today suggests that markets no longer expect meaningful further easing. This signal becomes clearer in the fiscal context set out in the Budget. The government’s projected net borrowing for FY2027 stands at around INR 11.7 trillion, broadly unchanged from last year; even as the gross borrowing number has zoomed to INR 19.7 trillion in FY2027 from INR 16.2 trillion in FY2026. The absence of a material reduction in sovereign demand for funds leaves limited room for yields to soften, keeping borrowing costs elevated across the curve. 

In his address, the RBI governor noted that while system liquidity has remained in surplus on a daily average basis since the last MPC meeting, the moderation in surplus liquidity indicates that financial conditions are no longer easing at the margin. With a substantial portion of the cumulative policy rate cuts already transmitted to lending and deposit rates, the incremental impact of further easing on borrowing costs is likely to be limited. 

The RBI governor observed that following cumulative repo rate cuts of 125 bps, lending rates on fresh rupee loans declined by 105 bps, while fresh deposit rates fell by 95 bps, with slower adjustment in outstanding deposits. While transmission has been substantial, financial conditions have tightened at the margin, with hardening bond yields and a recent firming in money-market rates amid moderating surplus liquidity. To counter this, the governor committed to proactive, pre-emptive liquidity management, ensuring that the banking system has sufficient “durable” funds to meet the economy’s productive requirements without stalling the impact of previous policy easing. 

Alongside this, the central bank announced a set of targeted regulatory and credit measures aimed at sustaining credit momentum, which has accelerated to 13.8% year-on-year. These include doubling the collateral-free lending limit for MSMEs to INR 2 million, permitting banks to lend to REITs under prudential safeguards, removing the INR 2.5 trillion cap under the Voluntary Retention Route, introducing frameworks for corporate bond derivatives, and strengthening consumer protection through a INR 25,000 compensation framework for small-value digital fraud.  

Against this backdrop, the RBI’s pause serves a stabilising function. It acknowledges inflation risks while recognising that credit conditions are increasingly being shaped by fiscal supply, liquidity dynamics, and market expectations rather than by incremental policy moves. The RBI governor’s assurance of “durable liquidity measures” fits this balance—supporting system functioning without reopening the easing cycle. 

This article has been revised to reflect the correct inflation projections for Q1 and Q2 FY2027 from the December 2025 MPC meet. An earlier version inadvertently stated them at 2.3% and 2.5%, respectively.

Cover photo credit: Shapoorji Pallonji

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