RBI aims to attract stable capital, ease external financing: Prateek Ancha

Today, the Reserve Bank of India held the policy rate unchanged at 5.25 per cent, and the stance remains neutral. This was, in essence, a “wait-and-watch” policy move as India's growth risks are rising, largely driven by the Middle East conflict. At the same time, inflation risks are skewed to the upside, with second-round effects explicitly flagged as a concern. In other words, both sides of the RBI’s mandate are now under stress. 

 

The case for patience is defensible. Inflation, at least for now, remains below target, even after edging higher in recent months. Recent fuel price increases would feed into inflation, and food prices are likely to come under pressure as well due to seasonal trends and a weak monsoon. While inflation is projected to rise toward the upper tolerance band by the third quarter, policymakers expect some easing later as supply conditions normalise. That conditional optimism explains the current pause: tightening prematurely risks choking growth just as external headwinds intensify. 

 

 

The more interesting question is how long such a stance can be maintained. If inflation does, as projected, rise toward the upper tolerance band, and especially if second-round effects begin to materialise, the case for tightening will become progressively stronger. Conversely, if global shocks intensify and growth falters more sharply, the central bank may find itself under pressure to support activity despite inflationary risks. 

 

For now, policymakers are betting on time: time for supply chains to heal, for global energy markets to stabilise, and for domestic resilience to hold. In our view, this is a reasonable strategy. 

 

However, major advanced economy central banks, including the ECB, the BoJ, and the BoK are expected to tilt toward tighter policy amid inflation concerns. Financial conditions are tightening globally, as reflected in rising bond yields. For an emerging market like India, this external backdrop reduces policy flexibility: tightening amplifies growth risks, but holding rates unchanged may result in continued currency pressure and imported inflation. 

 

Thus, monetary policy alone cannot do the job. What India needs is a buffer against external financing stress. And that is precisely what the RBI and the government have begun to build.

 

First, we explore the steps from the RBI. It expanded foreign access to long-tenor government bonds and eased FPI investment limits. Overseas equity participation norms were liberalised for NRIs and other non-residents. To bolster dollar liquidity, the central bank introduced concessional forex swaps for ECBs and subsidised hedging for new FCNR(B) deposits. Additionally, export realisation timelines were normalised. Together, these measures aim to attract stable capital, ease external financing conditions, and support the balance of payments. We expect these steps to lead to capital inflows of at least $40bn in the next one year. 

 

Secondly, the government has brought an Income Tax amendment ordinance that seeks to exempt foreign investors from income earned from certain government securities. This is a welcome move. In the past, research showed that how current taxation made investing in Indian bonds unattractive and if the tax exemptions were granted, it may lead to India’s inclusion in global bond benchmark indices, which could result in another $45-50bn of inflows.

 

By pre-emptively strengthening external buffers, through FCNR deposits, ECB incentives, and capital market liberalisation, the RBI is buying policy space. 

 

The risk, of course, is that this window proves temporary. If inflation accelerates further or capital outflows intensify, the central bank may yet be forced into a more conventional tightening response.

 

For now, the RBI has made a calculated choice: hold the line on interest rates but reinforce the balance of payments.

 

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(Disclaimer: This article is by Prateek Ancha, SVP I - business economic research, Axis Bank. Views expressed are his own.)