RBI policy review: Patience Over Hawkish Signals
In line with our expectation, the MPC voted unanimously to keep the policy rate unchanged at 5.25% while maintaining a ‘neutral stance’. RBI’s decision was underpinned by a downward revision in its inflation estimate while GDP growth was revised upwards by 10bps. The commentary around inflation hinted at a dovish tilt from the central bank and signalled a patient wait and watch approach rather than providing any hawkish forward guidance. That said, while the possibility of a rate hike in the October meeting is limited, we continue to expect the RBI to start its rate hiking cycle in FY27 – with one rate hike of 25bps likely on the cards (possibility by the February 2027 meeting). We estimate inflation at 5% for FY27 and Q3 inflation close to 5.8%, with risks to our forecast tilted to the upside. On growth, we hold on to our estimate of 6.8% for FY27 and estimate Q1 growth close to 7.5%. We increasingly see an upside to our growth estimate for FY27 now.
A Dovish tilt: As expected RBI kept the policy rate unchanged at 5.25%. However, the policy outcome carried a definitive dovish undertone. Though inflation has picked up in recent months, MPC attributed this to a pick-up in food and fuel prices, noting that a broad-based increase in prices is yet to emerge. The RBI revised down its FY27 inflation forecast to 5.0%, highlighting that: (i) inflation is not becoming generalised; (ii) it is expected to peak in Q3 before moderating thereafter (H2 inflation average at 5.7% and Q1 FY28 estimated at 5.3%); (iii) core inflation remains low (projected at 4.3% in FY27); and (iv) the recent uptick in inflation should be read as a normalisation from last year's benign levels. GDP growth, meanwhile, was revised up by 10 bps to 6.7%. We continue to estimate CPI inflation at 5.0% for FY27, with risks tilted to the upside. We estimate GDP growth at 6.8% for FY27, given the strong momentum seen in economic activity. For Q1 FY27, we are tracking growth closer to 7.5%.
Rate hike still on the cards: The RBI's commentary suggests the bar for tightening remains high in the near term, with any rate action likely contingent on broad-based, second-round inflationary pressures rather than transient spikes in oil or food prices. That said, we expect the second-order effects of higher input costs to become visible from Q3 FY27 onwards, a view reinforced by management commentary across companies pointing to an impending pass-through of higher input prices to end consumers. This, combined with the risk of an El Niño impact, tilts the balance of inflation risk to the upside. Against this backdrop and as growth holds up, we expect the RBI to begin its rate-hiking cycle before the end of FY27.
Liquidity: In the post policy press conference, the governor highlighted that while liquidity conditions could improve over the coming weeks on account of the FCNR dollar flows, eventually there could be normalisation in liquidity beyond September as currency in circulation increases and given forward book maturities. Therefore, there was no hint towards the need for any durable liquidity absorption measures as of now. That said, we think that the room for any such measures would be determined by the extent of dollar flows that come in. In a scenario where an additional USD 40 bn comes through the swap facility in the coming months, we expect LAF liquidity average to improve to INR 4.0-4.5 lakh Cr during September to November (support from G-sec redemption as well). In this regard, RBI could move towards liquidity absorbing measures to align WACR with the policy repo rate. We see a higher probability for the RBI to announce sell/buy swap or longer tenure VRR rather than OMO sales to absorb this surplus liquidity in the system.
Liquidity surplus has improved in recent days averaging at INR 2.40 lakh Cr in August 2026 (till date) while durable liquidity stood at INR 5.4 lakh Cr as on 15th July 2026. The improvement in LAF liquidity was on account of month-end government spending and dollar flows under the special swap facility provided by the RBI. Total cumulative flows under the special swap facility stood at USD 40.8 bn as on 31st July 2026. However, the impact on liquidity has so far been limited as it was partly offset by higher FX intervention by the RBI (drag on liquidity). With signs of de-escalation in the West Asia conflict and moderation in crude oil prices, the volatility in the rupee has also come down, limiting the need for continued intervention by the RBI in the FX market.
Rupee View: The USD/INR was trading at 95.19 the time of writing vs. its previous closed of 95.36, drawing support from the moderation in crude oil prices and a weaker dollar. If signs of de-escalation in the West Asia conflict become durable, we expect USD/INR to shift to a range of 94.50-95.50 over the coming weeks.
Bond yields: India 10Y bond yield was trading at 6.788% at the time of writing vs. its previous close of 6.82% on account of the moderation in crude oil prices. In the near-term, we expect India 10Y bond yield to trade in the range of 6.75-6.85%. We expect that as system liquidity surplus rises further over the coming weeks, short-end rates could see further downward moves. At the long end of the curve, oil price movements along with elevated global yields (and interest rate expectations in the US) could also exert influence.