MPC saves one for the external shock

The Monetary Policy Committee (MPC) of the Reserve Bank of India concluded its three-day meeting on Wednesday. The committee voted unanimously to keep the policy repo rate unchanged at 5.50 per cent. The MPC also decided to continue with the neutral monetary policy stance.

The MPC noted the favorable domestic conditions like (i) inflation lower than estimates and closer to the lower bound of the policy tolerance limits; (ii) Robust growth, though below aspiration; (iii) transmission of the 100bps policy rate cuts continuing and its impact on the economy unfolding.

Urban consumer demand tepid, investment demand remains supported by govt capex

The MPC also noted that on the demand side: “Rural consumption remains resilient, while urban consumption revival, especially discretionary spending, is tepid.” However, “Fixed investment supported by buoyant government capex continues to support economic activity”.

Farm sector buoyant, services steady, industrial growth subdued

On the supply side, steady southwest monsoon is supporting kharif sowing, replenishing reservoir levels and boosting agriculture activity. Services activity also remains steady, though some high-frequency indicators recorded a modest expansion. Services PMI increased to an 11-month high of 60.5 in July 2025. Construction activity continues to exhibit resilience. However, growth in the industrial sector remained subdued and uneven across segments, pulled down by electricity and mining. While the manufacturing Purchasing Managers’ Index (PMI) remained elevated in Q1, the Index of Industrial Production (IIP) showed moderation.

Growth outlook strong, external challenges need to be watched closely

The MPC is of the view that the above normal southwest monsoon, lower inflation, rising capacity utilisation, and congenial financial conditions continue to support domestic economic activity.

The supportive monetary, regulatory and fiscal policies including robust government capital expenditure, should also boost demand. With sustained growth in construction and trade segments, the services sector is expected to remain buoyant in the coming months.

Prospects of external demand, however, remain uncertain amidst ongoing tariff announcements and trade negotiations. The headwinds emanating from prolonged geopolitical tensions, persisting global uncertainties, and volatility in global financial markets pose risks to the growth outlook.

The MPC maintained FY26 real GDP growth forecast at 6.5%.

Inflation to remain benign in FY26, to pick up in 1QFY27 on low base

The MPC that the inflation outlook for FY26 has become even more benign. Large favorable base effects combined with steady progress of the southwest monsoon, healthy kharif sowing, adequate reservoir levels and comfortable buffer stocks of foodgrains have contributed to this moderation.

CPI inflation, however, is likely to edge up above 4 per cent in Q4:2025-26 and beyond, as unfavorable base effects, and demand side factors from policy actions come into play. Barring any major negative shock to input prices, core inflation is likely to remain moderately above 4 per cent during the year. Weather-related shocks pose risks to inflation outlook. Considering all these factors, CPI inflation for FY26 is now projected at 3.1 per cent. CPI inflation for Q1FY27 is projected at 4.9 per cent with evenly balanced risks.

External sector resilient

India’s current account deficit (CAD) moderated to 0.6 per cent of GDP in FY25 from 0.7 per cent of GDP in FY24 due to robust services exports and strong remittances receipts despite higher merchandise trade deficit. Merchandise trade deficit further widened in Q1FY26. Robust services exports coupled with strong remittance receipts are expected to keep CAD within the sustainable level during the current financial year.

On the external financing side, gross foreign direct investment (FDI) to India remained strong during April-May 2025. However, net FDI moderated during this period due to higher outward FDI.

Foreign portfolio investment (FPI) inflows to EMEs have remained strong in May and June 2025. However, net FPI to India recorded outflows of US$ 0.8 billion in April-July 2025 due to outflows in the debt segment.

External commercial borrowings, on the other hand, witnessed higher net inflows compared to last year. Inflows under non-resident deposits too remained positive, albeit witnessing some moderation.

As on August 1, 2025, India’s foreign exchange reserves stood at US$ 688.9 billion, sufficient to cover more than 11 months of merchandise imports.

Overall, India’s external sector remains resilient.25 We remain confident of meeting our external financing requirements comfortably.

Liquidity remains comfortable, monetary transmission underway

System liquidity, as measured by the net position under the Liquidity Adjustment Facility (LAF), has been in surplus, on an average of ₹3.0 lakh crore per day since the last MPC, as compared to an average daily surplus of ₹1.6 lakh crore during the previous two months.

Going ahead, as the CRR cut announced in the last policy comes into effect in a staggered manner beginning September, it would further support liquidity conditions.

The comfortable liquidity in the banking system has reinforced transmission of the policy repo rate cuts to the money, bond and credit markets during the current easing cycle. In the credit market, the weighted average lending rate (WALR) of scheduled commercial banks declined by 71 basis points for fresh rupee loans (of which 55 bps is due to interest rate reduction) and 39 basis points for outstanding rupee loans from February 2025 to June 2025. On the deposit side, the weighted average domestic term deposit rate (WADTDR) on fresh deposits moderated by 87 bps during the same period. Moreover, the transmission to lending rates has been broad based across sectors.

Conclusion

In my view, the MPC sounded quite confident about the economic and monetary conditions. However, it repeatedly cited external geopolitical and trade related threat posing strong headwinds. I therefore read the latest pause on policy rates as a measure to preserve arsenal for a final push if the external environment worsens materially.

On Wednesday, the US president announced 25% extra (penal) tariffs on the imports from India, making the total tariffs to 50%, materially higher than the competitors. If a resolution to the latest implied sanctions on India, purportedly for importing crude oil from Russia, is not found, there could be significant pain in the economy in the near-term, till the policy, businesses and markets adjust to the new tariff regime.