Why the RBI kept rates on hold? The RBI’s decision to keep rates on hold was driven by several factors – 1) while inflation recently has come down leading to a downward revision in the forecast, a lot of this has been driven by volatile components like food while core inflation has inched up to 4.4% in June the RBI argued. In addition, it sees headline inflation rising to 4.4% in Q4 FY26 and 4.9% in Q1 FY27 due to an unfavourable base effect and therefore seems to have calibrated its policy response based on the forward-looking inflation trajectory. 2) The RBI sees that while economic activity trends are mixed, growth momentum is broadly holding up and it would want to wait and watch for how the transmission and impact of the 100bps rate cuts so far delivered plays out. 3) Finally, as we had expected, it signalled that tariff developments/outcome (and consequently its impact on growth) remained uncertain and therefore a response at this stage through a rate cut would be pre-mature.
Forward expectations: While a neutral stance indicates limited scope for further easing, the governor hinted that future action would be dependent on how growth performs – therefore, not closing the door on further rate cuts completely in the post policy press conference. Defacto given the inflation projections, the space for another 25-50bps rate cut remains in place, although the RBI would exercise that only if there is a significant downside risk to growth – both due to domestic activity performance and the tariff impact. Only if the tariff outcome becomes decisively negative between now and the October policy, the probability of a rate cut could then increase for the October policy. For now, we expect that the policy rate remains unchanged at 5.5% for FY26.
Tariff impact: In our base case we project GDP growth at 6.3% for FY26 (lower than the RBI’s projection of 6.5%). However, in the case where tariffs remain elevated at current levels and/or are further raised we see a downside risk of 20-25bps to our GDP growth forecast for the year. On the one hand, while we see relative rupee depreciation, pick-up in rural activity, and frontloaded monetary easing and fiscal spending to provide support to growth, on the other hand, the impact of higher tariffs on exporters (particularly MSMEs), delay in capex plans and hiring present significant risks to the outlook.
Inflation: As widely expected, RBI revised down the inflation forecast for FY26 to 3.1% from the earlier 3.7%. Important to note, Q1FY27 inflation print is expected to average at 4.9%, bringing the real policy rate at 0.6% (assuming policy rate at 5.5%). The RBI estimates India’s real neutral policy rate between 1.4%-1.9% - a rate that is neither expansionary nor contractionary for the economy. Thus, with the current repo rate of 5.50%, monetary policy is estimated to remain accommodative from a 3 quarter ahead perspective as well. We expect inflation to average at 2.8% for FY26 given the continuing moderation in food prices. For FY27, we expect inflation to average at 5.1% and for Q1 FY27 inflation to average at 5.5%.
On liquidity, we continue to expect liquidity conditions to remain comfortable over this quarter and the RBI to announce fine tuning operations to align the WACR between the repo and SDF rate. On average the WACR stood at 5.31% in July 2025. In the near-term, the depreciation pressure on the rupee and the resulting intervention by the RBI could act as a drag on liquidity. If the depreciation pressures mount, the quantum of VRRR could reduce over the coming weeks and the possibility of a shift towards VRRs could arise to manage both frictional and intervention related outflows.
Liquidity framework: The RBI mentioned that the new liquidity framework recommendations are likely to be put into public domain for consultation soon. The governor clarified that the committee has recommend that the WACR continue as the operating target of monetary policy, given its high correlation with other money market instruments. This comes in the backdrop of increasing ask of shifting the operating target rate from the WACR to SORR or the TREPS rate given the increasing importance of the TREPS market in terms of borrowing and lending by banks and other market participants.
FX view: The USD/INR was trading lower at 87.67 the time of writing vs. its opening level of 87.72. In the near-term, given the continuing tariff related uncertainties, we expect the USD/INR to trade with a depreciation bias in a range of 87.00-88.50.
Bond view: India 10Y bond yield was trading higher at 6.38% at the time of writing vs the previous close of 6.33% as the RBI kept its policy rate unchanged and markets see limited probability for further rate cuts from the RBI in the current cycle. With the policy decision behind us, bond yields could be increasingly influenced by US yields and the tariff news flows over the coming days. On balance, we expect the 10-year yield to trade in a tight range of 6.30%-6.40% in the near-term.