New watchlist

The RBI in its latest Financial Stability Report, has cautioned about the emerging risks in the markets. In particular, the RBI highlights three risks to be watched carefully by the investors – (i) financial sector asset quality, especially for the private banks and small banks; (ii) valuation risk in the equities; and (iii) financial risks emanating from stablecoins and private credit.

Credit Quality is good, but needs to be watched

One of the clearest messages from the RBI’s latest Financial Stability Report is this: India’s banking system is in good shape, but some areas of concerns have emerged.

Banks today are better capitalized, more profitable and far cleaner than they were a decade ago. Capital adequacy ratios are well above regulatory requirements; liquidity buffers are comfortable and gross NPAs continue to trend down. Even under RBI’s worst-case stress scenarios, banks remain resilient.

For investors, this is a big positive. Strong banks mean smoother credit flow, better transmission of monetary policy and lower risk of sudden financial shocks.

But this is not a “no-risk” story.

The RBI flags specific pockets of concern—especially unsecured retail lending and microfinance. Some private banks have seen higher slippages and write-offs in unsecured personal loans. While this is not system-threatening yet, it is an area to monitor closely if economic conditions tighten.

On the NBFC side, balance sheets look stable and asset quality is improving. However, NBFC-MFIs face rising credit costs, and fintech-led unsecured lending is growing rapidly. Regulation and underwriting discipline will matter a lot going forward.​

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Banks and large NBFCs remain long-term structural winners. However, investors should prefer institutions with strong deposit franchises, conservative underwriting and diversified loan books. Avoid chasing growth at the cost of asset quality.

Lower volatility may be deceptive

If you only look at market volatility, everything seems fine. But the RBI tells a different story beneath the surface.

Equity valuations—globally and in India—are at the higher end of historical ranges. A small set of AI-linked stocks has driven a disproportionate share of global returns. This concentration makes markets vulnerable to sharp corrections if expectations change.

India has handled global shocks well so far, thanks to strong domestic investor flows and resilient earnings. SIP inflows into mutual funds continue to act as a stabiliser. But earnings forecasts have softened, and equity risk premiums are rising.

Bond markets are also adjusting. Government borrowing remains high, yield curves have steepened, and long-term bond demand from banks and insurers has moderated.

This is not a time for blind risk-taking. Quality matters more than momentum. Valuation discipline, earnings visibility and balance-sheet strength should drive investment decisions. Expect higher volatility, even if it hasn’t shown up yet.

Stablecoins, private credit & interconnected risks

One of the most important—and less discussed—parts of the FSR is its focus on new-age financial risks.

Stablecoins are growing fast and are now deeply linked to traditional financial markets, especially US Treasury markets. During stress events, stablecoin runs could amplify global liquidity shocks. While India’s direct exposure is limited, spillovers are real.

Private credit is another area of concern. Globally, opaque lending structures, leverage and interconnected financing raise the risk of hidden losses. Indian banks are increasing exposure to private credit vehicles, which needs careful monitoring.

Finally, financial interlinkages are growing. Banks, NBFCs, mutual funds and insurers are more connected than ever. This improves efficiency—but also means stress can spread faster.

Innovation is positive, but complexity increases risk. Investors should be cautious with businesses dependent on opaque funding, excessive leverage or regulatory arbitrage. Transparency and governance will be key differentiators.

Bottomline for investors

India’s financial system is strong, but this is a phase for selectivity, patience and risk awareness—not complacency.

 

RBI Financial Stability Report (FSR) – December 2025

The December 2025 Financial Stability Report (FSR) presents a cautiously optimistic assessment of India’s financial system amid a volatile and uncertain global environment. While global macro-financial risks remain elevated due to geopolitical tensions, trade fragmentation, stretched asset valuations and rising public debt, India stands out as a relative anchor of stability, supported by strong domestic demand, improving balance sheets and prudent regulation.  

High global growth masks vulnerabilities

Globally, growth has surprised on the upside in 2025, aided by front-loaded trade, fiscal support and unprecedented investment in artificial intelligence (AI). However, the RBI flags that this apparent resilience masks deeper vulnerabilities. Equity valuations, particularly in AI-linked stocks, are stretched, hedge fund leverage is rising, private credit markets are expanding rapidly with limited transparency, and stablecoins are becoming more systemically relevant. The disconnect between high uncertainty and low market volatility raises the risk of abrupt corrections. A disorderly adjustment in global risk assets, especially US equities, could have meaningful spillovers across emerging markets.

Indian economy remains resilient

Against this backdrop, India’s macroeconomic fundamentals remain robust. Real GDP growth exceeded expectations in the first half of FY26, driven by strong private consumption and sustained public capital expenditure. Inflation has moderated materially, fiscal consolidation is progressing, and India’s sovereign rating was upgraded by S&P in August 2025. The external sector remains resilient, with a manageable current account deficit, improving financial account balance, and foreign exchange reserves providing more than 11 months of import cover.

Domestic financial system remains robust

The domestic financial system continues to display strength across institutions and markets. Scheduled Commercial Banks (SCBs) report strong capital adequacy, ample liquidity buffers, improving asset quality and stable profitability. Stress tests indicate that even under severe macroeconomic shocks, banks would maintain capital well above regulatory thresholds. Credit growth has revived, with improving risk profiles in both corporate and household lending, though pockets of stress remain in unsecured retail loans and microfinance.

Non-Banking Financial Companies (NBFCs) also remain resilient. Capital positions are strong, asset quality is improving and profitability is stable. While NBFC-MFIs have seen some rise in credit costs, overall systemic risk remains contained. Importantly, stress tests suggest that aggregate NBFC capital would remain above regulatory requirements even under adverse scenarios.

Financial markets stable despite foreign outflows

Financial markets in India have been relatively stable despite global volatility. Equity markets have been supported by strong domestic institutional investor flows, resilient SIP inflows and improving corporate earnings. However, valuations remain at the higher end of historical ranges, and earnings expectations have softened. Bond markets are adjusting to higher sovereign issuance and a steepening yield curve, while demand for long-term government securities from traditional institutional investors has moderated.

A notable theme in the report is the growing interconnectedness between banks, NBFCs, mutual funds and other financial entities. While this enhances credit transmission and financial deepening, it also amplifies contagion risks during stress episodes. The RBI’s network and contagion analysis shows that while the system is resilient, shocks can propagate faster in an increasingly interconnected environment.

The report also places emphasis on emerging risks from stablecoins, private credit, climate finance and artificial intelligence. Stablecoins, in particular, are highlighted as a potential channel of cross-border spillovers due to their scale, reserve composition and links to traditional financial markets.

Regulatory framework continuously strengthening

On the regulatory front, Indian authorities continue to strengthen resilience through enhanced supervision, improved governance standards, simplified regulatory frameworks and stronger customer and investor protection. The approach remains balanced—supporting innovation and growth while safeguarding systemic stability.

In conclusion, the December 2025 FSR reinforces confidence in India’s financial system. Strong growth, sound institutions and sizable buffers provide resilience against global shocks. However, elevated asset valuations, global spillover risks and evolving non-bank and digital finance channels warrant continued vigilance. For investors, India remains a structurally strong but tactically selective opportunity.

…more on this tomorrow 

Why the market is not buying “Goldilocks”

In a rare instance of exuberance, the RBI governor termed the present moment as “rare Goldilocks period” of the Indian company, after cutting the policy rates by 25bps and quietly opening the liquidity taps. This should have enthused the financial markets but to the contrary, markets have turned even more cautious; especially, the foreign investors. This market behavior phenomenon might raise several questions in the minds of small investors. For example, -

·         Whether the rate cut decision is driven by conventional macroeconomic and monetary policy conditions, i.e., to support growth, considering that growth rate is already high and above the RBI estimates or the decision is driven by non-monetary policy considerations, e.g., driving bond yields down in anticipation of larger borrowing targets in FY27, or to drive INR further lower to help exporters manage tariff situation well, etc.?

·         Is the RBI more concerned about global situation worsening impacting India’s external balance and a redux of 2013 like BoP crisis?

·         Is the RBI really confident about measures taken to stem FII/FDI outflows or it is accepting outflows as a fait accompli?

·         Is Inflation sustainably pivoted below RBI tolerance band or it's just seasonally down and may rise again in 2026?

·         Whether the RBI also does not rely on quality of GDP growth data and believes actual growth to be slower and hence feels the need for rate cut to provide support?

In my view, these doubts may be unfounded.

Summary of RBI policy statement

Policy rates and stance

Repo rate: cut by 25 bps to 5.25% (unanimous).

SDF: cut by 25bps to 5.00%

MSF / Bank Rate: cut by 25bps to 5.50%

Policy Stance: maintained “neutral” (one member wanted it to be accommodative) .

Growth outlook (RBI’s own numbers):

Q2 FY26 real GDP growth: 8.2%, six-quarter high.

H1 FY26: 8.0% growth, 2.2% inflation – RBI calls this a “rare Goldilocks period”.

FY26 GDP forecast raised to 7.3% (from 6.8%): Q3-7.0%; Q4-6.5%; Q1FY27-6.7%; Q2FY27-6.8%

Inflation outlook (this is the big story):

Q2 FY26 avg CPI: 1.7%, below the 2% lower band for the first time under FIT.

October 2025 CPI: 0.3% y/y – lowest in the current CPI series.

Food prices in Oct: –3.7% y/y; vegetables –27.6%, cereals –16.2%.

FY26 CPI forecast cut to just 2.0%: Q3-0.6%; Q4: 2.9%; Q1FY27-3.9%; Q2FY27-4.0%

Core ex-gold inflation in Oct: 2.6%; RBI says nearly 80% of CPI basket is now below 4% inflation, a broad-based disinflation.

External sector

CAD: 1.3% of GDP in Q2 FY26 (down from 2.2% a year ago).

Trade: Oct trade deficit $41.7 bn (all-time high).

Services exports & remittances are strong; RBI expects “modest” CAD for FY26.

FX reserves: $686.2 bn, >11 months import cover.

External debt/GDP down to 18.9%; net IIP improved.

FDI: gross +19.4% y/y in H1; net FDI +127.6%.

FPI: small net outflow of $0.7 bn so far in FY26, driven by equities.

Liquidity & operations

System liquidity: average ₹1.5 lakh crore surplus since the Oct meeting.

RBI announces two big additional moves: OMO purchases of G-secs worth ₹1,00,000 crore in Dec. 3-year USD/INR buy–sell swap of $5 bn this month.

Governor stresses

OMOs are for “durable liquidity”, not directly targeting G-sec yields.

LAF operations (repo/VRRR) handle short-term liquidity; both can run simultaneously.

Repo rate remains the primary monetary policy instrument.

Goldilocks

Growth: 8%+ in H1, with tax cuts, GST rationalisation, and capex doing the heavy lifting.

Inflation: crashed to levels that make inflation-targeting central bankers in advanced economies slightly jealous (and maybe a bit suspicious).

Credit conditions: Banks & NBFCs well-capitalised, low NPAs, credit growth ~11–13% and rising.

Policy support: The RBI has done four cuts this year, total 125 bps, latest repo at 5.25% with a neutral stance.

Primary reading

In my view, prima facie, disinflation has given RBI room; it’s using it to ease conditions without declaring a full-blown easing cycle. Durable liquidity addition may flatten the yield curve slightly; therefore, investors need to watch for an appropriate time to increase duration. To answer the doubts, my view is as follows:

Conventional macro driver: yes – inflation far below target plus expectation of only mild growth softening.

Non-monetary flavor: also yes – the OMO + FX swap combination clearly supports bond yields and provides FX/liquidity comfort.

External worries: acknowledged but framed as manageable; policy is not being tightened for external reasons.

Inflation: seen as temporarily too low but structurally under control; forecast path rises towards 4%, not above it.

Growth data: RBI leans into the official strength and even upgrades forecasts; no sign they’re cutting because they think “true” growth is collapsing.

I would therefore explain the rate cut by:

The cut is better explained by:

·         A genuine disinflation surprise,

·         A desire to re-align real rates downwards while growth is still strong,

·         And some prudence ahead of expected softening in growth, not a collapse.

Insofar as the near term market reaction is concerned, it may be driven by several matters that are technical in nature and unrelated to the policy measures. 

Refinement of the monetary policy framework in India

 The Reserve Bank of India adopted its current monetary policy framework in August 2016, under the governorship of Dr. Raghuram Rajan. This marked a major shift in the monetary policy formulation process in India.

In the pre-independence era, the function of monetary policy was mainly to maintain the sterling parity, with the exchange rate being the nominal anchor of monetary policy. Liquidity was regulated through open market operations (OMOs), bank rate and cash reserve ratio (CRR). After independence, India adopted the planning model of development, loosely based on the USSR model. The role of RBI monetary policy in this model was mostly to regulate credit availability, employing OMOs, set bank rate and reserve requirement in congruence with the planning objectives and development needs of the country.

The monetary policy framework witnessed a major shift between from mid 1980s to late 1990s. In 1985, on the recommendation of the (Dr. Sukhamoy) Chakravarty Committee, a new monetary policy framework was implemented. This framework was primarily based on targeting with feedback models. This framework was termed “Monetary Targeting with Feedback” as it was flexible enough to accommodate changes in output growth. The RBI was mandated to control inflation within acceptable levels with desired output growth. Further, instead of following a fixed target for money supply growth, a range was followed which was subject to mid-year adjustments.

Developments like deregulation of interest rates, integration of the Indian economy with the global economy, liberalization of the exchange rate system, etc. in the mid 1990s, warranted a change in the monetary policy approach. The RBI began to deemphasize the role of monetary aggregates and implemented a multiple indicator approach (MIA) to monetary policy in 1998 encompassing all economic and financial variables that influence the major objectives outlined in the Preamble of the RBI Act. This was done in two phases—initially MIA and later augmented MIA (AMIA) which included forward looking variables and time series models.

The current monetary policy framework of the RBI was adopted in 2016. This framework was based on the recommendations of the (Dr. Urjit) Patel Committee report. The Committee recommended a monetary policy framework that was largely based on the US FOMC model – flexible inflation targeting by RBI and a six-member statutory Monetary Policy Committee (MPC) for setting the policy repo rate. The key tools of monetary policy implementation under this framework have been the repo rate as the primary policy rate, supported by liquidity management tools like open market operations, standing deposit facility, and marginal standing facility.

The Monetary Policy Framework Agreement (MPFA) was signed between the Government of India and the RBI in February 2015 to formally adopt the flexible inflation targeting (FIT) framework. This was followed up with the amendment to the RBI Act, 1934 in May 2016 to provide a statutory basis for the implementation of the FIT framework. The Central Government notified in the Official Gazette dated August 5, 2016, that the Consumer Price Index (CPI) inflation target would be 4% with ± 2% tolerance band for the period from August 5, 2016 to March 31, 2021. The same tolerance band has however continued even after the March 2021 deadline.

The framework has, so far, helped anchor inflation expectations, reduce inflation volatility (from 7.5% pre-2016 to ~5% post-2016), and support growth, though challenges remain due to supply-side shocks (e.g., food and fuel prices) and external spillovers.

The RBI has now released a discussion paper listing proposals to suitably refine the extant monetary policy framework, to address emerging economic challenges, such as supply shocks, global uncertainties, and climate-related risks. The goal is to maintain price stability while supporting economic growth and financial stability in a dynamic global and domestic environment.

Proposed refinements

Inflation target and tolerance band: Retain the 4% CPI inflation target but review the ±2% tolerance band. RBI proposes (i) narrow the band (e.g., ±1.5%) for stricter inflation control; or (ii) maintain the current band but clarify its use to avoid misinterpretation as a range for persistent deviation; or (iii) Introduce asymmetric bands (e.g., tighter upper bound to prioritize high inflation control). RBI also suggests considering core inflation (excluding volatile food and fuel prices) as a secondary guide to better reflect demand-driven pressures. Public comments are invited by September 30, 2025, on key questions: Should the 4% target or ±2% band be revised?

Scope of inflation targeting: Continue using headline CPI as the primary metric due to its broad coverage and public relevance. Explore supplementary indicators (e.g., core inflation, inflation expectations, or sectoral indices) to address supply shocks like food price spikes, which are less responsive to monetary policy.

Monetary policy committee (MPC) processes: Enhance transparency through more detailed MPC minutes and forward guidance on policy intentions. Propose increasing the frequency of MPC meetings (e.g., monthly instead of bimonthly) to respond more swiftly to economic developments. Consider expanding external member expertise to include climate economics and global trade specialists.

Incorporating new challenges: RBI proposes to incorporate certain contemporary challenges in the process of setting monetary policy. These new challenges include - (i) Climate Risks: Integrate climate-related risks (e.g., weather-induced food price shocks) into the framework, potentially through adjusted forecasting models or stress-testing scenarios. (ii) Digitalization and Fintech: Account for the impact of digital currencies and fintech on money supply and monetary transmission. (iii) Global Spillovers: Strengthen coordination with global central banks to mitigate the impact of external shocks (e.g., U.S. Federal Reserve rate hikes, commodity price volatility).

Monetary policy transmission: Address lags and inefficiencies in policy transmission (e.g., slow pass-through of rate changes to lending rates) by improving banking sector competition and liquidity management. The RBI proposed exploring alternative tools, such as forward guidance or yield curve control, to enhance transmission in volatile markets.

Growth and financial stability: Balance inflation control with growth objectives, especially in the context of India’s post-pandemic recovery and structural reforms. Strengthen coordination between monetary and fiscal policies to avoid conflicting signals (e.g., high fiscal deficits undermining inflation control).

Rationale for Review

Changing economic landscape: Rising supply-side shocks (e.g., food and energy prices, climate disruptions) and global uncertainties (e.g., geopolitical tensions, monetary tightening in advanced economies) require a more adaptive framework.

Inflation dynamics: Persistent food inflation and volatile global commodity prices challenge the FIT framework’s effectiveness.

Stakeholder feedback: Public and expert consultations highlight the need for greater clarity on the tolerance band and flexibility in addressing non-monetary inflation drivers.

 

Expected Impact

Price Stability: A refined framework could better anchor inflation expectations, reducing volatility.

Economic Growth: Enhanced flexibility may support growth without compromising inflation control.

Resilience: Addressing climate and global risks could make the framework more robust to shocks.

Challenges: Narrowing the tolerance band or increasing meeting frequency may strain RBI resources and require careful calibration to avoid over-tightening.

Chairman Powell stopped just short of committing a cut

 Federal Reserve Chair Jerome Powell delivered his final keynote address at the Jackson Hole Economic Symposium on August 22, 2025, hosted by the Federal Reserve Bank of Kansas City. The speech focused on the U.S. economic outlook and the Federal Reserve’s monetary policy framework review, addressing the Fed’s dual mandate of price stability and maximum employment.

In his speech, Powell noted the U.S. economy’s resilience despite challenges from President Donald Trump’s tariffs and immigration policies. Inflation remains above the Fed’s 2% target (PCE index at 2.6% in June 2025), driven partly by tariff-related price increases, while the labor market shows signs of weakening, with July’s job growth at 73,000, well below expectations, and downward revisions of 258,000 jobs for May and June.

Monetary Policy Outlook: Powell signaled openness to interest rate cuts at the September 16-17, 2025, FOMC meeting, admitting that monetary policy is in restrictive territory, and the baseline outlook and the shifting balance of risks may warrant adjusting the policy stance. However, he avoided committing to a specific timeline or size of cuts, citing mixed signals from rising inflation and a cooling job market.

The CME FedWatch tool showed a 74% probability of a September rate cut, down from near certainty earlier in August, reflecting uncertainty about the size and timing.

Powell also spoke about Fed’s revised “Statement on Longer-Run Goals and Monetary Policy Strategy”, emphasizing adjustments to address evolving economic conditions, such as demographic shifts and productivity changes affecting labor markets.

Political Pressures: While Powell did not directly address political pressures, the speech occurred amid President Trump’s criticisms of the Fed’s independence, including calls for Fed Governor Lisa Cook’s resignation and Powell’s own potential replacement, as his term ends in May 2026.

How experts read Powell lips

Market experts, participants, and media provided varied interpretations of Powell’s speech, reflecting its cautious tone and the complex economic environment:

Analysts at Barclays and BNP Paribas revised their forecasts to predict a September rate cut, interpreting Powell’s remarks as dovish, though he avoided endorsing large cuts (e.g., 50 basis points) sought by some Republicans.

Experts highlighted Powell’s acknowledgment of a “challenging dichotomy” between tariff-driven inflation and a weakening labor market. Deutsche Bank analysts noted that a hawkish stance could unsettle markets, particularly for rate-sensitive sectors like homebuilders and small caps. Conversely, a dovish tilt was seen as supportive of equities.

Media outlets, including The Guardian and Reuters, emphasized the political backdrop, with Trump’s attacks on Fed independence overshadowing the speech. Trump’s comment, “He should have cut them a year ago. He’s too late,” underscored tensions, with some analysts concerned about the Fed’s autonomy.

Overall, experts and media saw Powell’s speech as a balancing act, addressing economic challenges while navigating political pressures and maintaining Fed credibility. The lack of a clear commitment to rate cuts left room for interpretation, with some viewing it as pragmatic and others as overly cautious.

Global Perspective

The presence of other central bankers, such as ECB President Christine Lagarde and Bank of England Governor Andrew Bailey, at the symposium, highlighted global monetary policy coordination challenges. Media noted the symposium’s focus on labor market transitions and data quality issues, with declining survey participation affecting economic projections.

Market Reaction

Financial markets responded positively to Powell’s dovish tilt, interpreting his openness to rate cuts as supportive of growth.

The S&P 500 rose approximately 1.5–1.6%, the Nasdaq Composite climbed nearly 2%, and the Dow Jones Industrial Average surged 1.9–2%, reaching a record intraday high. The rally reflected relief at the prospect of looser monetary policy, particularly for growth-oriented and rate-sensitive stocks.

U.S. Treasury yields fell, with the two-year Treasury yield dropping nearly 10 basis points to 3.69% and the 10-year yield declining 6 basis points to 4.27%. The yield curve steepened, with the spread between 5- and 30-year rates hitting a cycle high, reflecting mixed expectations for inflation and growth.

The U.S. dollar weakened against a basket of currencies, including the euro and yen, with the Bloomberg Dollar Spot Index falling about 0.4%. This reflected expectations of lower rates reducing the dollar’s appeal.

Options pricing indicated an expected S&P 500 move of about 0.8% in either direction, nearly twice the average daily move over the past month, underscoring the speech’s anticipated impact.

The market’s upbeat response contrasted with pre-speech jitters, as Wall Street had been on edge, with the S&P 500 declining for five consecutive days prior to August 22 due to uncertainty over Powell’s stance and disappointing retail earnings.

Conclusion

Powell’s Jackson Hole speech last week, signaled a potential shift toward rate cuts in September, driven by labor market concerns, but stopped short of a firm commitment due to persistent inflation risks from tariffs. Market experts and media viewed the speech as cautiously dovish, navigating a complex economic and political landscape. Markets reacted positively, with equities rallying, bond yields falling, and the dollar weakening, reflecting optimism about potential monetary easing. However, the lack of definitive guidance and ongoing political pressures left some uncertainty, with analysts bracing for volatility depending on future economic data and Fed actions.

I however do not see a significant impact of the US market reaction on the Indian markets in the near term. Any enthusiastic response to the elevated rate cut hopes might be met with some aggressive selling.

Back home, the Reserve Bank of India (RBI) has recently released a discussion paper listing proposals to suitably refine the extant monetary policy framework, to address emerging economic challenges, such as supply shocks, global uncertainties, and climate-related risks. More on this in my next post.

Wish the readers A Happy Ganesh Utsav. May the Lord of Intellect and Conscience, remove all our obstacles created by our greed, ignorance, ego, intolerance, lust, material attachment, etc., and bless us with wisdom, contentment and peace.

Should the market be celebrating low inflation?

In July 2025, India’s consumer price inflation (CPI) hit an eight year low of 1.55% (yoy). Several factors contributed to the fall in inflation, including, a favorable base effect, lower fuel inflation, and decline in beverages and food prices. Since the inflation is much below the RBI tolerance range of 4% to 6%, it has excited the market participants about another rate cut at the RBI’s October 2025 Monetary Policy Committee (MPC) meeting. The prospect of lower Goods and Services Tax (GST) rates from November 2025, which could keep inflation subdued further, has added fuel to the speculations.

However, notwithstanding what RBI does at its next meeting, we need to answer a fundamental question - Is this low inflation—or even disinflation—a desirable thing for a growing economy like India?

Positive side of low inflation

Boost to Consumer Spending: Lower prices for essentials like vegetables and pulses mean more disposable income, which could spur consumption in a country where private spending drives nearly 60% of GDP.

Room for RBI Rate Cuts: Low inflation gives the RBI wiggle room to cut rates further, potentially by 25 basis points in October, reducing borrowing costs for businesses and homebuyers. Cheaper loans could ignite investment and housing demand, key pillars of India’s growth story.

GST relief on the horizon: Hopes of lower GST rates from November 2025 could be a game-changer. A reduction in GST, especially on essentials (which make up ~46% of the CPI basket), could keep inflation in check, further boosting purchasing power. This could amplify the RBI’s efforts to stimulate growth without stoking price pressures.

For a growing economy like India, projected to grow at 6.5-7% in FY26, low inflation creates a stable environment for businesses to plan investments and for consumers to spend confidently. No wonder markets are abuzz with optimism.

Why low inflation might be a problem

Low inflation, or worse, disinflation (a slowing rate of inflation), isn’t always a sign of economic health. For a dynamic economy like India, aiming to scale manufacturing and infrastructure, persistently low inflation could spell trouble.

Dampening capex enthusiasm: Low inflation often signals weak demand or excess supply. If prices stay too low, businesses may hesitate to invest in new factories, machinery, or tech upgrades—key drivers of capacity addition (capex). Why expand when profit margins are squeezed, and demand looks shaky? India’s GDP growth is already lacking triggers for acceleration, and a prolonged low-inflation environment could further sap corporate confidence.

Savings take a hit: Low inflation often leads to lower interest rates, as seen with the RBI’s recent cuts. While this is great for borrowers, it’s a blow to savers. Fixed deposits and small savings schemes, mainstay of Indian households’ savings, yield less in a low-rate regime. With real returns (adjusted for inflation) shrinking, households might cut back on savings, which fund bank lending and, ultimately, investment. India’s gross domestic savings rate, already down to 30.2% of GDP in FY24, could face further pressure.

Deflationary risks: If inflation dips too low—say, into disinflation or outright deflation—consumers might delay purchases, expecting prices to fall further. This could trigger a demand slump, hitting sectors like consumer durables and retail hard. Japan’s “lost decades” serve as a cautionary tale of how deflation can choke growth.

RBI’s warning bell: The RBI’s latest monetary policy review projects inflation rising to 4.6% in Q1 FY26, driven by potential food price spikes and global pressures like US tariff hikes (impacting 10.3% of the CPI basket). If businesses and consumers bank on low inflation now, only to face a sudden uptick, it could disrupt planning and erode confidence.

The GST wildcard

The anticipated GST rate cut from November 2025 could tilt the scales. Lower GST on essentials could keep inflation below the RBI’s projections, supporting consumer spending and giving the RBI more room to ease rates.

For instance, a 1% reduction in GST on food items could shave 0.1-0.2% off headline inflation, based on historical studies. This would be a boon for growth, especially in rural areas where food dominates household budgets.

But there’s a catch. Lower GST could reduce government revenue, limiting fiscal space for infrastructure spending—a key driver of India’s capex cycle. Plus, if global commodity prices or US tariffs spike, imported inflation could offset GST’s deflationary impact, forcing the RBI to rethink rate cuts.

Conclusion

Low inflation could be an opportunity as well as a challenge for India. In the short-term, it’s a tailwind—cheaper goods, lower borrowing costs, and potential GST relief could juice up consumption and growth. But sustained low inflation risks stifling capex and savings, which India can’t afford. The RBI’s cautious outlook for FY26, coupled with external risks, suggests it will tread carefully, likely opting for a modest 25-basis-point cut in October rather than aggressive easing.

Investors should watch the October MPC meeting closely and track GST reform updates. Sectors like consumer goods and banking could benefit from lower rates and higher spending, but keep an eye on capex-heavy industries like infrastructure and manufacturing for signs of slowdown. For now, enjoy the calm—but don’t bet the farm on it lasting.

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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.

India’s US$736.3bn debt challenge: Can it weather a US tariff storm?

 India’s external debt hit US$736.3bn by March 2025, a 10% jump from last year, with a significant portion (over 41%) of the debt maturing soon. As the US threatens 500% tariffs on countries buying Russian oil, including India, investors need to evaluate: Can India afford a confrontation with the US, China and other major trade partners, and could it withstand a covert economic embargo? Here’s my take, may be naïve and ill informed, but nonetheless relevant.

India’s External Debt

According to the Reserve Bank of India (RBI) latest release, India’s external debt stood at US$736.3bn at the end of March 2025, with a debt-to-GDP ratio of 19.1%. Key highlights of the data are:

Long-Term Debt: US$601.9bn, up US$60.6bn from last year, with commercial borrowings and non-resident deposits driving growth. About 77% (US$568bn) of this debt is owed by non-government entities. The non-government debt is almost equally divided between financial institutions (US$271.3bn) and non-financial corporations (US$261.7bn).

Short-Term Debt: US$134.5bn, representing 18.3% of total debt and 20.1% of foreign exchange reserves.

Components: About one half of external liabilities (US$251bn) is loans and debt securities, 22% currency and deposits and 18% trade credit. The rest 10% includes IMF SDRs and intercompany lending by MNCs.

Maturity: 41.2% of the external debt (about US$305bn), is due to mature within the next 12 months.

Debt Sustainability: Foreign exchange reserves cover 92.8% of total debt, down from 97.4% a year ago, signaling a slight decline in buffer capacity.

Refinancing challenge

With over 40% of long-term debt maturing soon, India faces a refinancing challenge, particularly if global financial conditions tighten or trade disruptions escalate. India’s reliance on Russian oil, which accounts for 35-40% of its crude imports (2.08 million barrels per day in June 2025), has put it in the crosshairs of a proposed US Senate bill. The “Sanctioning Russia Act of 2025,” backed by Senator Lindsey Graham and reportedly supported by President Trump, proposes a 500% tariff on countries importing Russian energy to pressure Moscow over Ukraine. India, alongside China, buys 70% of Russia’s oil exports, making it a prime target.

Economic Impact: A 500% tariff on Indian exports to the US, India’s largest export market, could affect US$66bn (87% of India’s US exports), as per Citi Research estimates. This could disrupt key sectors like pharmaceuticals, IT, and textiles, potentially triggering inflation and job losses.

Oil Dependency: India imports 88% of its crude oil, with Russia offering competitive discounts. Switching to costlier suppliers like the US or Middle East could raise import costs significantly, straining India’s trade balance.

Can India Afford a Confrontation?

India’s economic fundamentals offer some resilience but also expose vulnerabilities.

Forex Reserves: At US$703bn (as of recent data), India’s reserves cover 92.8% of external debt, providing a cushion to manage maturing obligations. However, refinancing US$270.9bn in long-term debt within a year could pressure reserves, especially if US tariffs disrupt export revenues.

Trade Dynamics: The US accounts for a US$45.6bn trade deficit with India. A trade war could prompt reciprocal tariffs, but India’s 12% trade-weighted average tariff (vs. the US’s 2.2%) limits its leverage. Negotiations for a trade deal to cut tariffs on US$23bn of US imports are underway, signaling India’s preference for diplomacy over confrontation; notwithstanding some recent comments of senior ministers that suggest otherwise.

Oil Alternatives: India has diversified its oil imports, with the US supplying 6.3% (439,000 bpd in June 2025) and West Asia 35-40%. While switching from Russian oil is feasible, it would increase costs, potentially impacting fuel prices and inflation.

Can India Sustain Virtual Economic Sanctions?

Virtual economic sanctions, such as the proposed 500% tariffs, or Chinese embargo on export of critical components, chemicals, human resources etc., would act as a severe trade barrier.India’s ability to sustain them depends on several factors.

Energy Security: India’s strategic reserves (9-10 days of imports) and diversified suppliers (US, Nigeria, Middle East) provide short-term flexibility. However, replacing Russia’s 40% share at higher costs could strain refiners and consumers.

Economic Resilience: The RBI’s Financial Stability Report (July 2025) highlights strong banking sector metrics, with declining non-performing assets and robust capital buffers. This suggests India’s financial system could absorb some shocks, but prolonged trade disruptions could erode confidence.

Need for caution

India’s debt remains manageable for now, but over 41% debt maturity in 12 months calls for vigilance. Investors in Indian bonds or banking stocks should monitor refinancing risks.

A US tariff war could hit export-driven sectors like IT and pharmaceuticals hardest. India’s diplomatic efforts to secure a trade deal or tariff waiver will be critical. A successful negotiation could stabilize markets, while failure could spark volatility.

Conclusion

India’s US$736.3bn external debt and looming maturities pose challenges, but its reserves and diversified oil sources provide a buffer. A full-blown confrontation with the US seems unlikely, given India’s diplomatic push and economic stakes. However, sustaining virtual sanctions would strain India’s trade balance and energy costs, making de-escalation the smarter play.

The 41% of external debt (US$305bn) maturing within 12 months is significant, requiring substantial refinancing or reserve drawdowns. India’s US$703bn forex reserves provide coverage, but a US tariff war could reduce export revenues, complicating debt servicing.

Sustained 500% tariffs would disrupt exports, weaken the rupee, and increase debt servicing costs. The RBI’s strong banking sector provides some stability, but prolonged sanctions could erode investor confidence and slow growth.

India’s neutral geopolitical stance and trade deal negotiations (aiming to cut tariffs on US$23bn of US imports) indicate a strategy to avoid sanctions. A waiver or partial exemption is possible, given India’s strategic importance to the US.

Read with US$703bn may be just enough

US$703bn may be just enough

The Reserve Bank of India holds US$702.78bn in foreign exchange reserves. In the popular macroeconomic analysis, especially in the context of the equity market. this piece of data is often used as one of the points of comfort by analysts.

This data could be viewed from multiple standpoints. For example –

Is it adequate to pay for the necessary imports in the near term, assuming the worst-case scenario of no exports could be made and no remittances are received. Currently, India’s monthly imports are appx US$67bn. However, a material part of these imports is crude oil and bullion. A part of the crude oil and bullion is re-exported after refining/processing. I am unable to figure out the precise net import number for domestic usage, but it would be safe to assume that about three fourth of US$67bn, i.e., US$50bn is for domestic usage. Allowing another 20% for “avoidable in emergencies” category of imports, we have appx US$40bn/month import bill payment obligations. By this benchmark we have sufficient reserves to pay for appx 18months of imports. This is a very comfortable situation from conventional yardsticks.

However, we need to consider interest payment and debt repayment obligations also to assess the adequacy of the foreign exchange reserves.

As per the latest RBI release (see here), India’s total external liabilities stood at US$736.3bn as on 31^st March 2025. 41.2% or appx US$305bn of this debt is due for repayment within the next 12 months. Assuming an average interest rate of 5%, another ~US$35bn would be needed for interest repayments. This implies about half of our foreign exchange reserves are needed for debt servicing in the next 12 month. This matrix raises some questions on the adequacy of our US$703bn reserves.

It also highlights the importance of remittances (appx US$135bn in FY25), foreign portfolio investment (FPI) flows (appx US$13.6bn in CY2024, including equities and bonds), and net foreign direct investment (US$3.5bn in FY25). An adverse movement in any of these flow matrices could materially affect the external stability. This brings in the factors like geopolitical stability, internal political & law and order situation, relative valuations of Indian equities and bonds, market stability and integrity, domestic investment climate, foreign investment policy framework etc. into the picture. Any policy mistake, strife in foreign relations, civic unrest, overvaluation, fraud, scam etc. could adversely impact the external stability.

The news headlines like - “China restricting export of critical components and chemicals to India, withdrawing expert manpower from India” that can adversely affect exports or increase the cost of imports for Indian manufacturers; the US considering to impose tax on the outward remittances”, ‘the US considering 500% duties on countries importing oil from Russia”, etc., - makes one cautious about the external stability of the country.

The experts need to analyze the latest RBI data on India’s external liabilities. In particular, it needs to be assessed whether India can withstand a trade war with the US; a covert geopolitical confrontation with China; frequent cases of market manipulation; policies and procedures that make India a less attractive destination for foreign investments; worsening law & order situation on parochial issue like language, religion, regionalism, etc.

…more on this tomorrow 

Investors’ dilemma – Consolidation vs Capex vs Consumption

After several years of corporate & bank balance sheet repair and fiscal correction, the contours of India's next economic growth cycle are beginning to emerge. With the Reserve Bank of India (RBI) maintaining a growth-supportive stance; union government showing strong commitment to fiscal consolidation, easing financing pressures for the private sector; and global markets showing signs of stabilization as geopolitical confrontations ease and trade disputes settled; the stage is set for a potential economic upswing.

The spotlight is now on three competing themes — corporate consolidation, private capex, and household consumption — each pulling investor attention in different directions.

Corporate begin to re-leverage

After many years of deleveraging, corporate debt in India appears to have bottomed out and is now beginning to rise. This shift in trajectory marks a significant departure from the post-2016 era, where Indian companies focused on strengthening balance sheets following a wave of over-leveraged investments. According to recent analyses, corporate borrowing is rising as businesses seek to capitalize on emerging opportunities.

This shift is supported by a monetary environment that remains broadly pro-growth. The Reserve Bank of India (RBI) has maintained a balancing act between containing inflation and supporting economic momentum. Rates have been cut aggressively and RBI is pushing for a quick transmission.

Fiscal consolidation by the union government is also helping to ease crowding-out pressures in the credit markets. With the Centre projecting a glide path toward more sustainable fiscal deficits, room is being created for the private sector to tap into financial resources more freely.

RBI’s Growth-Supportive Stance and Fiscal Consolidation

The Reserve Bank of India has definitely turned growth supportive in the past one year, after maintaining a delicate balance between inflation growth. The rates have been cut aggressively and liquidity conditions have been made favorable. Targeted interventions to support small and medium enterprises (SMEs) and infrastructure projects, have bolstered private sector confidence.

Simultaneously, the Indian government’s commitment to fiscal consolidation has eased pressure on private financing. By reducing the fiscal deficit—projected to decline to 4.4% of GDP in FY26 from 5.6% in FY24—the government is crowding in private investment. Lower government borrowing means more capital is available for private enterprises, reducing competition for funds and potentially lowering borrowing costs. This synergy between monetary and fiscal policy is creating a fertile ground for private capex to flourish.

Global context changing quickly

Globally, financial markets have been navigating turbulent waters for the past some time. Monetary policies remained tight in major economies like the United States and the European Union. Geopolitical concerns were elevated as multiple war fronts were opened. The political regime changes in the US early this year, also triggered an intense trade war.

However, recent developments suggest a quick shift. There are conspicuous signs of geopolitical stability, particularly with noteworthy steps toward peace in conflict zones. The US administration is showing significant flexibility in negotiating trade deals, raising hopes for an early and durable end to tariff related conflicts. Inflationary pressures are also easing, especially with stable energy prices. These all factors combined raise hopes for a global monetary easing cycle. The US Federal Reserve and the European Central Bank have hinted at potential rate cuts in 2025, which could lower global borrowing costs and improve capital flows to emerging markets like India.

For India, this presents an opportunity to attract foreign portfolio investments (FPIs) to boost market sentiments, as well as foreign direct investment (FDI) for long-term projects, especially in manufacturing and green energy. The government’s Production-Linked Incentive (PLI) schemes and “Make in India” initiatives are well-positioned to capitalize on this opportunity, but execution will be key.

Investors’ dilemma

Amidst corporate optimism, supportive policy environment, positively turning global context, investors and traders are facing a dilemma – whether to stay bullish on the capex theme or turn focus towards the consumption theme that has been lagging behind for the past couple of years.

In my view, investors need to examine two things—

1.    What is driving this resurgence in corporate debt?” Is it being used to fund acquisitions of operating or stressed assets, or is it fueling fresh capacity creation?”

2.    Whether easing inflation, lower interest rates, good monsoon, and improved employment prospects due to capex translating to on-ground activity, will accelerate private consumption growth, or households will focus on repairing their balance sheets and increase savings?

What is driving this resurgence in corporate debt – Consolidation or capacity addition?

The distinction is crucial. While the former drives job creation, productivity, and long-term growth, the latter may only temporarily improve capital utilization rates and return metrics. Acquiring distressed assets or merging with competitors may lead to short-term efficiency gains but could delay the broader economic benefits of new capacity creation. Whereas, investments in fresh capacities could signal a long-term commitment to growth, aligning with India’s aspirations to become a global manufacturing hub.

While mergers and acquisitions (M&A) activity has been robust in the past few years, particularly in sectors like infrastructure and manufacturing, greenfield investments have seen limited areas like renewable energy (driven mostly by government incentives) and steel.

Equity markets are evidently betting on a capital investment Supercycle. Stocks of capital goods makers, construction contractors, and building material firms have seen sharp re-rating over the past year. Order books are swelling, and forward guidance from several listed players suggests growing optimism.

Consumption paradox

While the equity markets are bullish on capex-driven sectors, investor enthusiasm for household consumption remains subdued. This is puzzling, given the macroeconomic tailwinds that should theoretically support private consumption. Easing inflation, which dropped to 4.7% in mid-2025, coupled with the prospect of lower interest rates and improving employment prospects due to rising capex, should create a virtuous cycle of demand. Yet, private consumption, which accounts for nearly 60% of India’s GDP, has been lackluster over the past two years.

Several factors may explain this paradox. First, uneven income distribution means that the benefits of economic growth are not reaching all segments of the population equally. Rural consumption, in particular, has been hampered by volatile agricultural incomes and inadequate infrastructure. Second, high inflation in essential goods like food and fuel, despite overall moderation, continues to erode purchasing power for lower- and middle-income households. Third, policy support in the form of subsidies and cash transfers is being gradually unwound as fiscal discipline returns. Finally, the stress in the household balance sheet, especially in the wake of the Covid-19 pandemic may have also hampered consumption growth.

The equity market’s lack of enthusiasm for consumption-driven sectors like FMCG (fast-moving consumer goods) and retail reflects these concerns. Investors appear to be betting on a capex-led recovery rather than a consumption-driven one, prioritizing sectors poised to benefit from infrastructure spending and industrial growth. However, sustained economic growth will require a revival in household consumption, as capex alone cannot drive inclusive prosperity.

What to do?

The question is what investors should do under the present circumstances? Should they continue to back the obvious beneficiaries of capex — engineering firms, infra developers, lenders to industry? Or should they begin building positions in consumption plays, in anticipation of a cyclical rebound?

In my view, both themes may ultimately play out — but on different timelines. Capex is here and now, led by policy push and balance sheet strength. Consumption is the laggard, but if the macro indicators hold, its turn could come with a lag of a few quarters.