An apt policy: RBI may tighten credit later but its current focus is on attracting flows of foreign exchange

The Reserve Bank of India’s (RBI) credit policy is important not just from the point of view of the repo rate and stance, but also the commentary which goes along with it on the state of the economy. While the state of the economy is covered by RBI’s monthly Bulletin, close attention is paid to what the policy states.

The June policy is even more significant because India’s economic situation is anomalous. First, the latest inflation number is 3.5% while GDP growth last year was 7.6%. Going by indications given by RBI at different points of time, the economy is resilient with positive tendencies. This is the goldilocks tale—which has now become a cliché.

But it is also obvious that inflation will rise and growth will decline due to the impact of the West Asia war and possible sub-normal monsoon rains affecting India’s kharif crop.

Against this background, four basic elements of RBI’s policy can be looked at.

First, a pause on the repo rate, as unanimously decided by the Monetary Policy Committee. While policy should be forward looking, it is true that no one knows how long the war will last and what oil marketing companies will do with fuel prices in India.

Therefore a wait-and-watch position is prudent; so the repo rate was left unchanged at 5.25%. As there is a policy call every two months, remedial action can be taken in case inflation turns nasty. Given RBI’s raised forecast for 2026-27, it looks like we can expect repo hikes from October onwards.

Second, RBI’s policy stance was left unchanged at neutral. This is logical and gels with the unchanged repo rate and uncertain future environment. Any change in the stance would have affected market sentiment, which means that bond yields could be affected. Hence, it is better not to upset the apple-cart right now, with the 10-year yield on government paper hovering around 7%.

Third is the inflation forecast.

This is critical because it indicates likely future action. RBI has raised its inflation forecast for 2026-27 to 5.1% from 4.6% made back in April. More importantly, the trajectory for the four quarters is projected at 4.2%, 5.1%, 5.9% and 5.4% respectively.

None of these numbers indicates that inflation will go beyond the 6% upper limit RBI’s target band. But by its own forecast, the third quarter will see it coming very close. It does look as if RBI has accounted for the impact of a relatively weak monsoon in that quarter, which is pragmatic.

Fourth is economic growth. This number is tricky, as it comes just before the National Statistical Office releases last year’s data. GDP growth in 2025-26 was initially put at 7.6%. This year, RBI expects 6.6% growth, which is lower than the earlier take of 6.9%.

We can assume that consumption and investment—both on the demand side—will drive it down, while exports would be dull. Higher inflation can be expected to weigh on growth, which, though lower than last year’s pace, is still steady in relative terms.

The market reaction has been as follows. The 10-year bond has remained virtually unchanged and the rupee strengthened by 20-25 paise, thanks in part to measures announced by RBI to boost capital flows. The stock market did not move much. Business as usual?

The central bank’s governor Sanjay Malhotra spoke of the external situation, which was probably what market participants were awaiting most keenly—for affirmative action on the forex front.

Some measures have been announced to draw in foreign funds, with foreign portfolio investors simultaneously being given further incentives by the Union government to invest in G-Secs. Public sector units can raise external commercial borrowings through a swap facility for four months, while the hedging costs of banks raising fresh foreign currency non-resident deposits would be taken on by RBI.

What can be drawn from the policy announced on Friday is that RBI will remain steadfast in its approach to controlling excess exchange-rate volatility, but will not seek any specific rupee level against the US dollar.

Hence, to sum up, the policy is taking a wait-and-watch approach on rates, while we can probably expect a rate hike during the course of this fiscal year, given India’s inflation trajectory. RBI assured the banking system of liquidity and took some steps to get in more forex flows. Quite appropriate, under the conditions.

These are the author’s personal views

The author is chief economist, Bank of Baroda, and author of ‘Corporate Quirks: The Darker Side of the Sun’