Context:
This article discusses the Reserve Bank of India’s (RBI) recent Monetary Policy Committee (MPC) meeting, focusing on its evaluation of inflation trends, GDP growth forecasts, external trade challenges, and the outlook for future monetary policy.

RBI’s Monetary Policy Stance:

·       The RBI decided to keep the repo rate unchanged and maintained a neutral policy stance.

·       Since February 2025, the central bank has already reduced the policy rate by 100 basis points (bps).

·       Given that Consumer Price Index (CPI) inflation is projected to exceed 4% in 2026, further rate reductions are unlikely in the current cycle.

Inflation Outlook:

·       Current Trends: CPI inflation experienced a sharp decline to about 2% in June 2025 and is forecasted to remain around 2.5% for the following two quarters.
The CPI inflation projection for FY26 has been revised downward to 3.1%, driven by statistical base effects and deflation in vegetable prices.

·       Vegetable Price Volatility: Vegetable inflation was very high in 2024, averaging 27%, but has recently seen significant deflation, averaging -15% over the last three months.
The vegetable price sub-index, which carries a 6% weight in the overall CPI, remains highly volatile. Excluding vegetable prices, CPI inflation stayed within a 3-4% range throughout FY25 and continues in that range in Q1 FY26.

·       Future Projections: Due to the reversal of the base effect, CPI inflation is expected to cross the 4% mark in Q4 FY26. For FY27, CPI inflation could average above 4.5%, consistent with RBI’s estimates.

Growth Projections and Domestic Factors:

·       GDP Outlook: The RBI retained its GDP growth forecast for FY26 at 5%, signaling confidence in the country’s growth trajectory.

·       Supportive Factors: The outlook benefits from earlier interest rate cuts, robust agricultural output, a benign inflation environment, favorable monsoon conditions, and a reduced income tax burden.

·       Consumption and Employment Concerns: Urban consumption remains subdued due to weak income growth and a slowdown in hiring, especially in the IT sector. The top five IT firms have reported stagnant employment levels, and employee cost growth across 670 companies declined sharply from 14% during FY19–FY24 to 5% in FY25.

·       Investment Trends: Public capital expenditure surged by 52% in Q1 FY26, indicating strong government investment. However, private sector investment remains cautious amid ongoing economic uncertainties.

External Sector and Trade Dynamics:

·       External Risks: Reciprocal tariffs imposed by the U.S. present risks to India’s external sector. Merchandise exports are expected to contract in FY26, though service exports remain resilient.

·       Current Account and Forex Reserves: India’s current account deficit is forecasted to be manageable at 0.9% of GDP for FY26. Foreign exchange reserves stand at a comfortable $689 billion, sufficient to cover 11 months of merchandise imports. This provides a broad insulation for India’s external sector, though vigilance is necessary.

Policy Outlook – Wait-and-Watch Approach:

·       With real interest rates low, approximately 1%, and liquidity conditions ample, the RBI is likely to pause further rate cuts.

·       Any additional easing would depend on a significant growth slowdown triggered by external shocks.

Conclusion:

The RBI’s approach balances cautious optimism, reflecting a nuanced understanding of the evolving macroeconomic landscape. Sustaining domestic demand, employing strategic policy adjustments, and maintaining alertness toward inflationary pressures and external risks will be vital for preserving economic stability through FY26 and beyond.