Rate cut? Status quo likely in Aug monetary policy despite inflation dip

RBI set to lower inflation projection, but GDP growth estimate and policy stance may remain unchanged

Indian central bank’s rate-setting body, the Monetary Policy Committee (MPC), will hold its third bi-monthly meeting of the current financial year between August 4 and 6. There’s consensus among economists and market watchers on two critical aspects of the August monetary policy.

 

One, the Reserve Bank of India (RBI) will pare its inflation estimate for the year, and two, the growth estimate will remain unchanged.

 

In the June policy, the RBI had projected the consumer price index (CPI)-based inflation rate for financial year 2025-26 (FY26) at 3.7 per cent, lowering its April projection of 4 per cent.

 

CPI inflation dropped to its 77-month low of 2.1 per cent in June. In July, it is set to dip further, below 2 per cent. Inflation has been undershooting the RBI estimate through the current financial year. The 2.1 per cent inflation in June makes the average April-June quarter inflation 2.69 per cent, below the RBI estimate of 2.9 per cent.

 

The RBI's inflation estimate for FY26 is 3.7 per cent (2.9 per cent for the first quarter; 3.4 for the second; 3.9 for the third; and 4.4 per cent for the fourth quarter). Till December, retail inflation is likely to undershoot the RBI estimate; the average inflation for FY26 could be around 3.4 per cent.

 

In its June policy, the RBI did not change its projection for gross domestic product (GDP) growth for the year. It remained at 6.5 per cent, with risks evenly balanced. In its February policy, the RBI had projected 6.7 per cent GDP growth for FY26 but trimmed it to 6.5 per cent in April and stuck to that in June. This is in sync with the estimates of Moody’s Ratings and S&P Global Ratings.

 

The finance ministry’s monthly economic review for June expressed cautious optimism on the growth front. Despite monetary easing and strong balance sheets of banks, credit growth has slowed. This is an area of concern. Slow credit growth and lack of appetite for private investment — they are both sides of the same coin — are the risk factors for growth.

 

Meanwhile, the International Monetary Fund (IMF) has raised its growth outlook for India to 6.4 per cent in FY26 from its April projection of 6.2 per cent, citing a “benign external environment” and lower inflation. It has also increased India’s GDP forecast for FY27 to 6.4 per cent. On a calendar year basis, the IMF pegs India’s GDP growth at 6.7 per cent in 2025 and 6.4 per cent in 2026.

 

The IMF Global Economic Outlook Update, released on July 29, flagged significant risks, warning of a further hike in US tariffs in August. Indeed, that has happened, and the external environment for India is not benign at the moment. Still, the RBI is expected to stick to its 6.5 per cent GDP estimate for FY26 at this week’s meeting. 

 

What about interest rates?

 

The June policy reduced the repo rate — the rate at which the RBI lends money to banks — for the third successive time. The three rate cuts since February — the last being a 50-basis point (bp) cut — have brought the repo rate down from 6.5 per cent to 5.5 per cent in four months. One bp is a hundredth of a percentage point.

 

The action-packed last policy also pared the cash reserve ratio (CRR) by 100 bps to 3 per cent. CRR is the portion of net demand and time liabilities — a loose proxy for deposits — which commercial banks keep with the RBI. They do not earn any interest on this. Staggered over four instalments between September 6 and November 26, the CRR cut will release Rs 2.5 trillion into the system.

 

Finally, in June, the RBI also changed the stance of the policy — from accommodative to neutral.

 

The RBI governor’s statement on the last policy had pointed out that the MPC would be carefully assessing the incoming data and the evolving outlook to chart out the future course of monetary policy in order to strike the right growth-inflation balance.

 

A few economists — they are in the minority, though — expect yet another rate cut this week, bringing down the repo rate to 5.25 per cent. The reasons? Inflation will undershoot the RBI estimate, and the growth impulse is still weak. India's industrial production growth, measured by the index of industrial production (IIP), hit a 10-month low of 1.5 per cent in June 2025.

 

Till the second week of July, the year-on-year credit growth (that is, between July 2024 and July 2025) is 9.8 per cent, sharply down from 14 per cent a year ago. The growth in deposits is also down, although by not such a wide margin — from 11.3 per cent to 10.1 per cent.

 

Since there is scope for another rate cut, why delay? Let’s do it now, they say. In other words, frontload the cut — something the RBI had already done in June, to give growth a big push. This year, the festive season is also frontloaded. As transmission takes time, an August rate cut will help boost consumer demand during Diwali in October.

 

But aren't there stronger reasons for holding on for now? If a 100-bps rate cut has not been able to push consumer demand, how much difference can another 25-bps rate cut make? Shouldn’t the RBI wait for the transmission of the series of rate cuts that happened between February and June? After all, India’s growth story is not threatened in a big way.

 

Besides, the joker in the pack is the local currency. The rupee tested its new closing low vis-à-vis the dollar last week. Lower local rates make dollar-denominated assets more attractive for investors. This makes the dollar stronger and the rupee weaker.

 

The RBI has continuously been draining liquidity from the system by holding variable rate reverse repo (V-RRR) auctions and bringing the overnight rate within the liquidity adjustment facility (LAF) corridor. Three policy rates create the corridor: The standing deposit facility (SDF) rate is the floor; the repo rate rests in the middle; and the marginal standing facility (MSF) rate is the ceiling. Currently, the repo rate is 5.5 per cent, SDF 5.25 per cent, and MSF 5.75 per cent. The RBI does not want the weighted average overnight call rate to drop to the floor. This signals its discomfort with lowering the rate at the moment.

 

If the RBI decides to wait for the October policy to take a call on the rate cut, besides some clarity on the external front, it will have on its table the June quarter GDP data, status of the monsoon, and the outcome of the next meeting of the US Federal Reserve’s rate-setting body, the Federal Open Market Committee (FOMC), which will be held on September 16-17.

 

On expected lines, in the last week of July, the FOMC maintained the status quo (US Fed rate at 4.25–4.5 per cent) for the fifth consecutive meeting, although the decision was not unanimous — two of 11 voting members dissented. The policy statement was broadly unchanged. It spoke about the uncertain outlook even as inflation remained “somewhat elevated” and the unemployment rate “low.” Its assessment of the state of the economy broadly remained unchanged.

 

The stance of the Indian monetary policy this week should remain neutral for the time being, even if the RBI decides to go for the last round of rate cut in October. Yes, there could be just one more cut, if at all, and there’s not much scope for a dramatic fall in the policy rate.

 

On a low base effect, the CPI inflation may not be as benign in FY27 as in the current year. The RBI governor at his policy press conference indicated it could be around 4.5 per cent. The rise in inflation will shrink the real interest rate — the policy rate minus the rate of inflation. But this is not the time to speculate on that. For now, status quo is par for the course. 

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