December monetary policy a close call; all eyes on RBI's communication

With inflation at a record low of 0.25% and robust GDP growth, the RBI faces a close call between supporting the economy and a weakening rupee

Those who were expecting a pre-Diwali gift from the Reserve Bank of India (RBI) in October were disappointed when the Indian central bank’s Monetary Policy Committee (MPC) left the policy repo rate unchanged at 5.5 per cent. On December 5, when the MPC ends its three-day bimonthly monetary policy meeting, the last in this calendar year, will RBI Governor Sanjay Malhotra play the Santa Claus and bring an early Christmas? 

After the status quo in two successive monetary policies of August and October, it will be a close call in December.

 

The growth-inflation dynamic always plays a critical role in formulation of the monetary policy for all central banks. From this perspective, the backdrop of the December policy is interesting as the consumer price index (CPI) -based inflation in October, at more than a decade low, creates space for a rate cut and, at the same time, the economy is on a firm growth path. The slipping of the rupee against the greenback adds another dimension, tilting the mood in favour of the status quo. But the central bank has been dropping hints on the space for a rate cut. 

Gross domestic product (GDP) continues to surprise on higher side. India’s real GDP grew 8.2 per cent in the second quarter of the current financial year, surpassing the consensus estimate of 7.3 per cent. CPI-based inflation eased sharply to 0.25 per cent in October from 1.44 per cent in September. The rupee, after breaching the 89 level a week ago, ended at 89.45 a dollar last Friday (November 28). 

In October, the MPC noted that the growth outlook was resilient, supported by domestic drivers, despite uncertainties on the external front. It found the domestic structural reforms helping to somewhat offset the drag on growth from the weakening external demand conditions. The macroeconomic conditions and the outlook, the MPC noted, opened up policy space for further supporting growth. 

The market lapped up the MPC observation. The 10-year government bond yield, which was 6.58 per cent ahead of the last policy, dropped to 6.52 per cent after the policy on the last policy day. It had been in a narrow range since then and closed at 6.545 last Friday. 

Will the MPC keep its word and bite the bullet in December? 

Let’s first take a look at the growth and inflation data. 

After growing at 7.8 per cent in the first quarter (April-June) of 2025-26 (FY26), GDP’s 8.2 per cent growth in the second quarter is driven primarily by robust growth in manufacturing, services and agriculture. 

CPI-based inflation eased sharply to 0.25 per cent in October from 1.44 per cent in September, the lowest year-on-year inflation print since the introduction of the current CPI series (base year 2012), with the food basket slipping deeper into deflation – (-)5.02 per cent. 

A sharp drop in food prices apart, the first-round impact of the rationalisation of the goods and services tax (GST) rates and a favourable base effect played a role in pushing down retail inflation. Last month, retail prices slipped into deflationary zone in rural India, even as urban inflation moderated from 1.83 per cent in September to 0.88 per cent in October. 

The pace of price rise in October, at 0.25 per cent, is far below the RBI’s inflation tolerance range of 2 per cent to 6 per cent. Incidentally, this is the third time since July that the CPI-based inflation rate has come in below the lower tolerance limit of the RBI’s inflation target band. And, for nine months in a row – since February 2024 – the CPI-based inflation rate has remained 

below 4 per cent. 

The latest print is sharply lower than the RBI’s inflation projection of 1.8 per cent for the October-December quarter. This means that unless inflation rises sharply in the next two months, the third quarter retail inflation may once again undershoot the central bank’s forecast. 

So, is a cut in the policy rate in December given? No. It will be a close call. Why? Because of the 8 per cent growth in the first half of FY26. Besides, a falling rupee is a disincentive for a rate cut.

 

A section of analysts says the central bank could have gone for a rate cut in October. Now, when the growth is on a firm footing, and the rupee is depreciating, the scope of a rate cut is limited. 

Despite the current low inflation trajectory, the RBI had estimated in October that inflation would rise to 4 per cent in the January-March quarter and 4.5 per cent in the first quarter of FY27. However, it pared its overall inflation estimate for the year — for a third straight time, after having done so both in June and August. It projected the CPI-based inflation rate for FY26 at 2.67 per cent. In August, this had been pared from 3.7 per cent to 3.1 per cent, and before that, in June, from 4 per cent to 3.7 per cent. 

The RBI also raised the real GDP growth rate estimate for the current financial year from 6.5 per cent to 6.8 per cent in October. 

The RBI may pare its inflation projection and raises the growth projection for the year, yet again. 

Considering the pros and cons, the latest retail inflation data creates some space for a rate cut but the scope is limited. At best, the RBI could go for a quarter per cent rate cut if it sees downside risks to growth because of the uncertainties surrounding the tariff and/or the consumption recovery’s failure to sustain the momentum beyond the festival season. The tariffs will have a bearing on the labour-intensive micro, small and medium enterprises and end up offsetting the positive impact of GST cuts on growth, analysts say. 

Of course, if a trade deal is reached with the US and bilateral tariffs are reduced, the downside risk to GDP growth will be much lower. 

More than action, the markets will watch the RBI’s communication. If there is a rate cut, how will the RBI communicate when the growth is on a firm footing? And, if there is no action, why the status quo despite record-low inflation? 

In October, the RBI had left both the policy rate and stance unchanged, but Governor Malhotra had made a point that the current macroeconomic conditions and the outlook had opened up policy space to further support growth. 

The central bank didn’t go for a rate cut then and chose to wait as the impact of the frontloaded monetary policy actions and the fiscal measures were still unfolding, apart from the evolving trade-related uncertainties. At that juncture, the MPC thought it was prudent to wait for the impact of past policy actions to play out, and greater clarity to emerge, before charting the next course of action. 

It had also stuck to the “neutral” monetary policy stance. But, unlike in the previous policy, in October, two of the Indian central bank's six-member rate-setting body were in favour of changing the stance to “accommodative”. 

Malhotra preferred to retain the neutral stance as any change to the accommodative stance at that stage would have been tantamount to giving a definitive forward guidance about the future trajectory of the policy rate. “The policy uncertainty, rapidly evolving developments and the foggy outlook suggest that we exercise caution and take a view for each policy in accordance with the then prevailing macroeconomic conditions and outlook,” he had said. 

A new GDP and CPI series will be released next year ahead of the RBI’s April 2016 policy. If the growth momentum continues and the new CPI series puts downward pressure on retail inflation, the high growth-low inflation dynamics could continue. 

Apart from any action on the rate front, the RBI needs to manage liquidity in the system when credit is set to pick up. It has cut the banks’ cash reserve ratio by 1 per cent in four equal tranches of a quarter per cent each, ending on November 29, unlocking ₹2.5 trillion. Systemic liquidity, which was volatile, is now settling at around the ₹1 trillion level. 

The average surplus liquidity, which was ₹2.7 trillion in the first half of September, reduced to ₹28,000 crore in the second half of the month with advance tax and GST-led outflows. After a volatile October, there has been adequate liquidity in the system in November. The CRR cut apart, the RBI has also been buying bonds in the secondary market through open-market operations even as intervention in the forex market through dollar sale is sucking out rupee liquidity.

The writer is an author and senior advisor to Jana Small Finance Bank Ltd. His latest book: Roller Coaster: An Affair with Banking. 

To read his previous columns, log on to www.bankerstrust.in

X: @TamalBandyo