Wait-and-watch mode: Why the RBI MPC is likely to hold interest rates

The rate-setting body is likely to remain in wait-and-watch mode as uncertainties continue to cloud the macroeconomic outlook

For central banks globally, the last fortnight was eventful. 

 

On Friday, the Bank of Japan kept its policy rate unchanged at 1 per cent, reiterating its willingness to raise borrowing costs if inflation risks increase. The two-day policy meeting ended in an 8-1 vote in favour of keeping the status quo after the mid-June quarter per cent hike to 1 per cent -- a level last seen in 1995.

 

A day before that, the Bank of England (BoE) too kept interest rates on hold, as expected. BoE's Monetary Policy Committee voted 6-3 to keep rates at 3.75 per cent. "Holding Bank Rate is appropriate as global conditions look to be more uncertain and inflationary, while domestic conditions are on balance more benign as regards the prospects for inflation," Governor Andrew Bailey said. BoE has been on hold since December 2025 after four rate cuts.

 

The US Federal Reserve kept interest rates unchanged early last week but three members of the Federal Open Market Committee (FOMC) said they would have preferred a quarter per cent rise, the first time since September 2016 when three policymakers dissented with a unified view of direction.

 

Fed Chair Kevin Warsh has "no tolerance" for inflation but, once again, at his second policy meeting, he refrained from providing any forward guidance, emphasising that future policy decisions would remain entirely dependent on incoming economic data. In the absence of forward guidance, markets are figuring out the timing and direction of policy rates in the coming months even as US bond yields are on the rise.

 

In the previous week, on 23 July, the European Central Bank (ECB), which had raised its benchmark interest rate by a quarter percentage point in mid-June, left it on hold at 2.25 per cent, citing heightened uncertainty. While the decision to keep rates steady was unanimous, ECB President Christine Lagarde said, “There were some governors who asked themselves whether we should not consider a hike”.

 

What do we expect from the Reserve Bank of India (RBI) this week? Its six-member Monetary Policy Committee kicks off its three-day meeting on Monday.

 

First, let’s take a look at how things have changed since its last policy announcement on June 5 which kept the rate unchanged at 5.25 per cent, raised the projection for inflation and lowered the estimate for growth.

 

The 10-year bond yield, which closed at 6.975 per cent on June 5, dropped to 6.685 per cent on July 6, its lowest in recent times. Last Friday, it closed at 6.83 per cent. Following the deferment of Indian government bonds’ inclusion in Bloomberg’s Global Aggregate Index, it is expected to rise.

 

The rupee closed at 94.94 a dollar on June 5. Over the next fortnight, by June 18, it rose to 94.33, bolstered by the RBI’s multi-pronged strategy to attract foreign capital. Last Friday, it closed at 95.39 a dollar, gaining substantially since it touched 96.57 on 23 July. On Saturday, the RBI said there had been an inflow of $40.82 billion since the window to attract foreign currency opened.

 

The RBI’s foreign currency assets which were $543.4 billion in the first week of June, rose to $555.9 billion by July 24. Overall foreign exchange reserves, however, remained unchanged during this period – at around $682 billion.

 

Why is forex flow not reflecting in reserves? There could be four reasons behind this – the RBI is selling dollars in spot market; it's allowing forward book (buy/sell position) to mature (not rolling over); and customers withdrawing from existing FCNR(B)/NRE accounts and putting it back through new FCNR(B) scheme. We see new flows in FCNR(B) but not outflow from the existing pile. Finally, the drop in the price of gold. Gold reserves were worth $114.57 billion on 5 June; by 24 July, this had fallen $103 billion, offsetting the rise in foreign currency assets. In fact, it had dropped more, a week before. 

 

Against this backdrop, I expect the rate-setting body of the India central bank to go for the status quo. The decision of no change in the policy rate could be unanimous.

 

Like the US FOMC, the MPC is likely to remain in a wait-and-watch mode as uncertainties continue to envelop the macroeconomic outlook. There are three key uncertainties, out of which, two are intertwined – Donal Trump and the price of oil. The price of Brent Crude was $93.09 per barrel on June 5. On Sunday, it dropped to $85. Since the last policy, it has yo-yoed between $71.57 and $100.69, floating on Trump’s action and the lack of it.

 

Meanwhile, the southwest monsoon’s erratic behaviour is likely to continue after an uneven run in June and July. The India Meteorological Department’s (IMD’s) monsoon outlook for the second half of the season talks about below-normal rainfall – less than 94 per cent of the long-period average (LPA) – in August for most parts of India. The forecast for August-September together, too, is below normal, less than 94 per cent of the LPA.

 

The Indian Ocean Dipole (IOD) – a climate pattern defined by the difference in sea surface temperatures between the western and eastern sectors of the tropical Indian Ocean – is currently neutral, with forecasts expecting it to shift toward a positive phase later in the season.

 

At the last policy meeting, the MPC unanimously decided to keep the policy repo rate unchanged. The stance also remained neutral.

 

The RBI cut down the real GDP growth estimate for FY27 from 6.9 per cent to 6.6 per cent with “downside” risks. Quarter-wise, the growth projections were revised to 6.6 per cent for the first quarter, 6.3 per cent for the second, 6.5 per cent for the third, and 6.8 per cent for the fourth quarter. 

 

Its projection for the consumer price index (CPI) inflation, was raised to 5.1 per cent for FY27 from 4.6 per cent earlier with upside risks. Here, the quarter-wise projections have been 4.2 per cent in the first quarter, 5.1 per cent in the second, 5.9 per cent in the third, and 5.4 per cent in the fourth quarter. Core inflation is projected at 4.7 per cent. The 5.1 per cent inflation projection is based on an assumption of crude price at $95 a barrel.

 

The CPI inflation in June rose to 4.38 per cent, year-on-year, breaching the central bank's target for the first time in 17 months. It was also higher than what most analysts had expected. The RBI follows a flexible inflation target – 4 per cent with a 2-percentage point band on either side. In the first quarter, the average CPI inflation was 3.93 per cent, below the RBI projection of 4.2 per cent but is likely to remain above 5 per cent for the next two quarters.

 

With no immediate serious threat to inflation and growth (Index of Industrial Production or IIP grew by 7.3 per cent year-on-year in June, accelerating from 5 per cent in May 2026, driven by strong performances in manufacturing and electricity), the RBI will go for the status quo both for the rate as well as the stance of the monetary policy. There is also likely to be no change in the inflation and GDP projection for the year.

 

Of course, there are challenges – the price of oil (influenced by the Trump factor) and imported inflation, the trajectory of the monsoon and its impact on food inflation, and the pressure on the rupee (the difference between the yield on US government bond and Indian bond has narrowed since the last policy, impacting the foreign money flow). The RBI will wait and watch how things pan out before changing its stance as a precursor to the rate hike which could happen by the year-end. 

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 Writes Banker's Trust every Monday in Business Standard.

 

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