The Reserve Bank of India’s Monetary Policy Committee (MPC) maintained the status quo on the monetary policy rate and its stance – remaining 5.25% and neutral – on Friday even as it lowered its growth forecast and raised inflation expectations for this year, while acknowledging the challenges ahead.
The Reserve Bank of India also announced a series of measures to attract more foreign capital into the economy. Analysts see his actions as a legitimate reiteration of the “decoupling principle” within India’s inflation targeting framework, where interest rates address the balance of growth and inflation and other measures are deployed to address external sector challenges.
The Indian economy is expected to grow by 6.6% in 2026-27 with inflation at 5.1%, according to the Monetary Policy Committee forecast released on Friday. The latest growth and inflation forecasts entail a 30 basis point downward revision of growth and an upward revision of inflation of 50 basis points from the April forecast. One basis point is one hundredth of a percentage point. Expected GDP growth next year is 110 basis points lower than the 7.7% growth in 2025-26, according to provisional growth figures for last year released on Friday.
The main reason behind the negative movement in the balance of growth and inflation is the imbalance resulting from the war in West Asia. “As the conflict in West Asia drags on with no real solution in sight, risks to both inflation and growth have increased,” the MPC decision notes.
The Monetary Policy Committee’s quarterly forecasts suggest that economic headwinds from the war will continue to impact over the entire year and not just the current period. Quarterly growth forecasts are now 6.6%, 6.3%, 6.5% and 6.8% for the June, September, December and March quarters instead of the April forecast of 6.8%, 6.7%, 7% and 7.2%. Inflation is expected to remain at 4.2%, 5.1%, 5.9% and 5.4% in the four quarters instead of 4%, 4.4%, 5.2% and 4.7% in the April forecast.
The economic situation is expected to get worse before it improves, as evidenced by the Monetary Policy Committee’s assessment that “although the economy has withstood the fallout from the conflict with limited impact so far, tensions are becoming increasingly evident.”
It was widely expected by markets that the MPC would not change interest rates, as inflation is expected to remain within the 4%-6% target range of the Reserve Bank of India. The Monetary Policy Committee stressed that it will “continue to be data-driven” in the future and monitor supply shocks, whether due to the ongoing war or weaker-than-normal monsoon rains. What comforts the MPC is the benign core inflation environment, which it believes will remain at 4.7% in 2026-27 and much lower if precious metals are excluded, and notes that “demand pressures remain under control” in the economy.
To be sure, what made Friday’s MPC meeting a closely watched event was not its usual interest rate response to growth and inflation dynamics under the inflation targeting mandate, but rather the turmoil on the external front manifesting itself in a significant depreciation of the rupee and mounting capital account pressures on the Indian economy. Although the MPC decision does not say much about this, given its mandate is limited to inflation targeting, Reserve Bank of India Governor Sanjay Malhotra has announced a slew of measures, along with the fiscal arm of economic policy, to address the challenges.
The essence of these announcements is to improve trading conditions for foreign investors in debt and equity markets. The measures announced (through a decree amending the Income Tax Law) include exemption from capital gains tax on investment in government bonds, allowing a greater role for foreign investors in equity and government bond markets. Governor Sanjay Malhotra said he expects a “healthy inflow of foreign exchange inflows” in response to the measures. He reiterated that there are no plans to impose any capital controls in the economy.
Experts welcomed these measures, but they believe that their ability to confront the challenge is partial.
“The raft of measures announced at today’s RBI meeting are comprehensive and wide-ranging. They address a number of concerns expressed by foreign investors and are likely to lead to an increase in capital flows over the coming months. This would help address some external financing concerns, but will not solve India’s structural balance of payments issues. We believe India needs approximately $7-8 billion a month in capital flows to balance the balance of payments. This is still significant, and although the measures may add up to $5 billion per month from Barclays A research note said that additional flows over the next few months will not fully fill the gap.
“First, as we have noted, India’s inflation targeting framework has created a principle of decoupling over the past decade, with interest rates and liquidity being used to tackle inflation while other tools (sterile currency market intervention and regulatory policy) are used to combat external sector pressures. We have therefore resisted the idea – embedded in market pricing – that the RBI will raise interest rates to defend the rupee. rupee,” JP Morgan chief economist Sajid Chinoy said in his note, adding that one of the portfolio’s announcements could aim to open up an important source of external fund inflow. “Earlier, the government eliminated all withholding taxes and capital gains taxes on government bonds for foreign portfolio investors,” Chinoy’s note says. The key is whether this, in conjunction with the expansion of the FAR path, will be enough for India to be included in the Bloomberg Barclays index, and attract a significant amount of sticky debt inflows.”
There could certainly be a rise in interest rates in the near term, according to some analysts. “We now expect a 25 basis point rate hike in the August (3Q26) meeting, followed by another hike in the October (4Q26) meeting, versus our previous expectation of two rate hikes during 4Q26 and 1Q27, taking the repo rate to 5.75%,” said Pranjul Bhandari, Managing Director, Chief Economist, India, HSBC.
