The Reserve Bank of India’s decision to keep policy interest rates unchanged at the February Monetary Policy Committee (MPC) meeting signals a phase of cautious consolidation. After cumulative rate cuts of 125 basis points in 2025, the pause reflects the central bank’s assessment that growth is holding up well and inflation risks remain contained, even as global uncertainty persists.
Why the RBI chose to hold rates
The rate pause by the follows a year of active monetary easing aimed at supporting growth. With headline inflation trending comfortably below the upper tolerance band and growth indicators showing resilience, the case for immediate further easing has weakened.
At the same time, the RBI has refrained from announcing fresh liquidity-enhancing measures, suggesting confidence that existing tools and discretionary interventions will be sufficient to manage short-term liquidity pressures.
Growth outlook: domestic momentum and trade relief
India’s macroeconomic indicators continue to point towards healthy momentum. Advance estimates suggest GDP growth of about 7.4 per cent in FY26. The outlook has further improved following progress on the India–US trade deal, which is expected to ease tariff pressures that had weighed on exports in recent months.
Between September and November 2025, India’s non-petroleum exports to the US contracted by 2.2 per cent, reflecting the impact of higher tariffs. Sectors such as gems and jewellery, textiles, ready-made garments, and chemicals were particularly affected. Since the US accounts for roughly one-fifth of India’s exports, tariff reductions could provide meaningful relief.
Impact of the India–US trade deal
Although the full details of the trade agreement are still awaited, early estimates suggest that lower tariffs could add around 0.2 percentage point to GDP growth. This could lift growth closer to 7.2 per cent in FY27, subject to revisions under the new GDP series.
The RBI itself has turned more optimistic, revising its growth projection for the first half upwards by 20 basis points. Alongside trade, India’s recent bilateral agreements with major economies, including the European Union, are also expected to support capital inflows and investor confidence.
Inflation remains benign
Inflation continues to offer comfort to policymakers. Headline inflation for the fourth quarter of FY26 is estimated at around 3.2 per cent, well within the RBI’s target range. Core inflation, excluding volatile components such as gold, stood at about 2.6 per cent in December 2025.
Assuming normal monsoon conditions, inflation is expected to average close to 4 per cent in FY27. However, the RBI and analysts remain cautious, as the introduction of a new CPI series could alter inflation dynamics and projections.
Liquidity conditions and forex interventions
Despite earlier liquidity-supporting measures, banking system liquidity has tightened in recent months. Average liquidity fell to around ₹0.7 trillion over the last two months, compared to ₹2 trillion during April–November 2025.
One key factor has been the RBI’s foreign exchange market interventions, which tend to absorb rupee liquidity. Going forward, the need for such interventions may reduce if capital inflows strengthen and the rupee finds support from improved trade prospects with the US.
Bond yields and borrowing pressures
An important challenge lies in the government bond market. Despite policy rate cuts, government securities (G-sec) yields have risen by about 45 basis points over the last eight months. The spread between the 10-year G-sec yield and the repo rate has widened to nearly 150 basis points.
Large gross borrowing requirements of the Centre for FY27 have exerted upward pressure on yields, compounded by high state government borrowings. The spread on 10-year state development loans over G-secs has nearly doubled from around 35 basis points at the start of the fiscal year to about 70 basis points.
Possible RBI response on bonds
To address demand–supply imbalances in the bond market, the RBI could consider open market operation (OMO) purchases. Such interventions would help stabilise yields and ensure smoother transmission of monetary policy, especially as credit demand picks up.
Maintaining orderly conditions in the bond market will be critical to keeping borrowing costs manageable for both governments and the private sector.
The road ahead for monetary policy
For now, the RBI is expected to maintain the status quo on policy rates. With growth holding firm and inflation under control, the central bank has chosen to preserve its policy ammunition. This flexibility could prove valuable if global financial conditions tighten or domestic shocks emerge.
The immediate focus is likely to remain on ensuring adequate liquidity, supporting the government bond market, and monitoring the evolving global environment, rather than on further rate adjustments.
What to note for Prelims?
- The RBI sets policy rates through the Monetary Policy Committee (MPC).
- Headline inflation target is 4%, with a tolerance band of ±2%.
- OMO purchases are a tool to manage liquidity and bond yields.
- G-sec yields reflect government borrowing conditions.
What to note for Mains?
- Analyse the rationale behind the RBI’s rate pause despite earlier easing.
- Discuss how trade agreements influence growth and monetary policy.
- Examine the relationship between fiscal borrowing and bond yields.
- Evaluate the role of liquidity management in effective monetary transmission.
