RBI emphatic on durable liquidity support; focus clearly on transmission

The repo rate decision by the monetary policy committee (MPC) in the December meeting was a close one. Multiple MPC members of late flagged the re-emergence of space for further monetary easing given the record-low CPI inflation. Thus, even though the large upside surprise in the Q2 GDP print last week caused some uncertainty, lowering the repo rate in December did not trigger any major surprise.

 

Liquidity support, especially durable liquidity, had much greater significance and the central bank has delivered decisively on this front, announcing OMO purchases of Rs 1 trillion and three-year $/rupee buy-sell swaps of $5 billion, injecting durable liquidity worth Rs 1.45 trillion during December. 

Lingering concerns of higher federal and state borrowings on the back of tax reforms, RBI’s forex market interventions and volatility in global financial markets have kept domestic yields sticky. Thus, the governor’s emphatic guidance today on supporting durable liquidity going forward will likely materially aid transmission to bond yields at this juncture and, thereby, lead to further softening in bank lending rates. 

As reiterated by the RBI today, India’s growth-inflation dynamics resemble a “Goldilocks” situation in recent quarters. Inflation has receded much faster than the central bank’s forecasts, with RBI now having revised its forecast for average CPI inflation for 2025-26 downwards by a massive 220 basis points between February and December 2025. The central bank now expects CPI inflation to average 2 per cent in 2025-26 and 4 per cent during the first half of 2026-27, which is 60 basis points lower than the last forecast merely two months back. The underlying inflationary pressures are even lower if adjusted for higher precious metal prices, which have been a major contributor to core inflation prints.

 

GDP growth projection for 2025-26 was also, expectedly, revised upwards by 50 basis points to 7.3 per cent year-on-year, marking its second consecutive upgrade. RBI expects growth momentum to remain on a decent footing, supported by strong rural demand and a gradual urban recovery.

 

Though domestic growth forces remain resilient, external headwinds including global policy uncertainties and geopolitical tensions continue to cloud the outlook. Even though the rupee has been under considerable pressure this year in a weakening dollar environment, India’s healthy forex reserves and favourable domestic macro-financial dynamics call for a balanced outlook.

 

With inflation expected to average around 3 per cent during the second half of 2025-26 to the first half of 2026-27, the current real rate would still be significantly north of the RBI’s perceived neutral real rate of 1.4-1.9 per cent, implying that the ongoing rate-easing cycle may not be over yet. However, emerging trends — such as transmission of lower rates to the financial sector and spillover risks from global trade dynamics and the US policy rate trajectory — mean that clear signalling, careful sequencing of future policy decisions, and proactive liquidity management will remain essential for achieving the policy’s intended objectives and rate transmission in the desired direction.

 

The author is chief economist and head of research at Bandhan Bank. The author thanks Sudarshan Bhattacharjee and Gaurav Mukherjee for assistance

 

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