RBI's monetary policy: navigating for growth in meager waters | Mint

The Reserve Bank of India had a challenging task of determining the course of interest rates and policy institution amid the volatility of the extreme currency, financial markets uncertainty and an edge on growth. However, the RBI Monetary Policy Committee has unequivocally addressed these challenges by announcing a rate reduction and moving the attitude of ‘neutral’ to ‘accommodating’, giving clear guidance and providing a supporting approach to India’s growth inflation dynamics. These dynamics justify the ‘accommodating’ attitude and create room for a 100 basis points repo rate cut during this cycle. Surplus -liquidity conditions further increase the transfer by lower deposit tariffs in the banking system. By reflecting on the attitude of liquidity management, RBI retained the operational flexibility to effectively address the liquidity needs. Although the direct impact of US reciprocal rates on India is limited, weaker global growth will affect India’s exports to the US. In our opinion, the additional rates announced so far are estimated to be reduced by India’s growth by 0.3% in 2025-26. Indirect consequences, such as the export of lower services, overpayments and foreign inflows, will also be felt. However, lower oil prices and policy support of RBI are expected to cushion. Therefore, RBI has reduced its GDP growth for FY26 by only 0.2 percentage points to 6.5%. The effectiveness of the RBI’s reduction of the repo rate will be driven by the velocity of the transfer, for which the central bank is prepared to provide liquidity to 1 percent NDTL (net demand and time obligations). Liquidity support must ensure that banks have access to funds at a lower cost than deposits for retail term, which accelerates the shipping. But for more effective transfer, banks must lower the deposit rates, which are determined by the competitive landscape and the real rate of return. As RBI has reduced its inflation prospects for FY26 to 4% from 4.2%, real returns are much more attractive and leave room for reduction. It is quite significant if it is seen in the context that it is after a period of six years that inflation will be in line with the RBI’s 4%target. Since the estimates of the central bank are based on oil prices at $ 70/barrel (current: $ 60/barrel), the chance of reaching the target is high. In addition, food inflation must also continue to alleviate, given a high base and higher production in the current year. Even for next year, the prediction is that the monsoon should be normal. So, even if global commodity prices rise from here, if India’s tariff negotiations with the US are successful, there is a significant pillow for inflation to align with the target. With RBI’s benign domestic inflation prospects and the significant wind winds to growth arising from the volatility of the financial market and the hit to global trade, RBI has changed its position to ‘accommodating’. Governor Sanjay Malhotra emphasized that the attitude lies ahead that RBI’s next tariff action would be either a cut or a break. We believe that the current global economic environment requests the MPC to continue to lower the rates to support growth. Since India’s current account deficit is unlikely to exceed 1% of GDP, even after the direct and indirect effects of the US rates have taken into account, there is room to continue on the path of lower interest rates. MPC has the option to hold on to rates if global volatility increases, which can cause the depreciation of the emerging market currencies, including the rupee. RBI has disconnected its position of liquidity, which gives it room to modulate liquidity, depending on the volatility of foreign exchange and volatility in the foreign exchange market. But in balance, the reciprocal rates imply US growth, which shows on a weaker dollar with the US federal reserve, which eventually cut interest rates to support employment. We believe that RBI has space to lower the repo rate by 100 basis points in the cycle, based on the real rate of 1.5%, as inflation is estimated at 4% in FY26 and 4.3% in FY27. In order to lower the policy rates, growth and inflation prospects must be much weaker, or the real rates should be reviewed lower. Given the fundamentals of India, we do not see a need to review real rates and potential growth lower. Even RBI’s own estimates show that growth is expected to take up in FY27 to 6.7%. RBI’s liquidity framework is currently being reviewed and we believe that the new framework will be in line with a surplus liquidity cenario rather than causing a deficiency. To summarize, given the increased uncertainty, RBI took the mantle to support growth, which should limit the impact on India’s economy and enable operational flexibility on liquidity to manage volatility that arises from the worldwide winds. We see that bond yields are lower within the next few months. B. Prasanna is head of the Treasury at ICICI Bank Ltd and Sameer Narang is Head, Economic Research Group.