Pause and reflect: Why February may not be the time for rate cuts

With FY25-26 CPI inflation likely to average at 2.1 per cent Year-on-Year and FY26-27 CPI inflation to still average below the 4.0 per cent target, the question of 'space' is still easy to answer

Having delivered 125 (basis points) bps of repo rate cuts, 1 per cent of cash reserve ratio (CRR) cut, a slew of steps for easing liquidity through open- market operations (OMO) purchases, FX buy/sell swaps and measures aimed at regulatory easing in 2025, we expect a quiet start to 2026 from monetary policy corridors. Not to imply that we don’t need more monetary policy support, but February 6 may not be the best time for it.

 

We believe it’s time to pause and reflect on measures already announced, market reaction to those measures, evaluate the ask for more and balance it with the best time to deliver. On December 5, he MPC announced a 25 bps policy rate cut, RBI committed to ₹1 trillion of OMO purchases and a $/ ₹ buy sell swap for $5 billion (3-Y tenor)- effectively overdelivered vs market expectations.  In normal times, this would have resulted in IGBs rallying, but about 2 months later we are +18bps/+23bps/+27bps on 2-Y/5-Y/10-Y IGBs – that too with OMO purchases of ₹4.2 trillion and total buy sell swaps of $25 billion and multiple long dated VRR operations. So, while the RBI is arguably doing all it takes to be there for markets, it seems that the pain is deeper than what words can heal.

 

At 6.75 per cent the 10-Y yield showcases the pain of likely excess supply, especially with the FY26-27 budget pegging net borrowings at ₹11.7 trillion (and gross borrowing at ₹17.2 trillion), both coming in higher than expected. Budget math in our view, is not just credible, but also conservative and balance of risk is in fact in overachieving the 4.3 per cent of GDP fiscal deficit target. 

 

The RBI is the banker to the government, and the central government paid ₹12.7 in interest payments in FY25-26 and will pay ₹14 trillion in FY27 (83 per cent of fiscal deficit), with borrowings rising relentlessly both at the centre and the state level, lower bond yields must be viewed as a public good, demanding policy priority. 

 

We believe the RBI will use the upcoming policy as an opportunity to reflect on how to deliver on this task at hand, likely choosing non-rate measures, striking a dovish hold. Moving from markets to economics, the RBI is an inflation-targeting central bank, with the mandate to keep CPI inflation close to the 4 per cent (+/-2 per cent) target range.

 

With FY25-26 CPI inflation likely to average at 2.1 per cent Year-on-Year and FY26-27 CPI inflation to still average below the 4.0 per cent target (current base), the question of ‘space’ is still easy to answer. We believe CPI inflation has troughed, not only has October-December CPI inflation averaged 20 bps higher than the MPC’s latest forecast, the risk of a similar surprise to the January-March inflation estimate is quite real.

 

But, here’s another twist, impending base revision and update of the CPI, we do not know for sure, what January 2026 CPI inflation may look like.  Add to that, as the revised base GDP series is released later this month, the growth numbers could potentially look very different from what they are currently. So, at a time when we await revised base numbers – for both inflation and GDP – which could have a bearing on the review of the inflation-targeting framework (expiring on March 31, 2026), Friday isn’t the best time to react.

 

We expect the RBI to continue with liquidity infusion measures, while keeping the repo rate unchanged, alongside dovish commentary, partly soothing markets, spooked after a budget which didn’t have too much for them.    The writer is India chief economist, Barclays