Timely inaction: On RBI’s decision to hold repo rate
The RBI Monetary Policy Committee’s (MPC) decision to keep interest rates unchanged — a “wait and watch” approach, in the Governor’s words — is a sensible move. At a time when hasty words and deeds have roiled world markets, economies, and even households, a measured policy response was the need of the hour. The challenge before the MPC is that the main tool it has — the repo rate — impacts growth and inflation in opposite ways. That is, if it had raised rates to try to contain an anticipated surge in inflation, this would have hurt growth. On the other hand, if it lowered rates to boost growth, this would have pushed inflation up. The war in West Asia has resulted in both of these undesirable outcomes: supply chain constraints have pushed up costs while also dragging down growth. A rate change at this juncture could have made matters significantly worse and further dampened the mood in the economy. In his speech, RBI Governor Sanjay Malhotra predicted that India’s GDP would grow 6.9% in 2026-27. Given that this is still the first month of the financial year, the forecast is likely to change considerably over the subsequent MPC announcements. For example, the MPC in April last year had predicted that growth in 2025-26 would be 6.5%. In contrast, the government’s latest estimate for the year is 7.6%. Considerable uncertainty continues to persist in West Asia, with shipping companies still hesitant to brave the Strait of Hormuz.
All of this, coupled with the fuel constraints, will continue to hamper growth in 2026-27. The RBI lowered its growth forecast for the first quarter by just 0.1 percentage points, which might end up being an over-optimistic reading of the situation. The World Bank’s India Development Update report, released on Thursday, predicts a slowdown in industrial growth in India over the course of this financial year. Consumer and government demand, too, is expected to slow as both groups try to tighten their belts. Inflation, on the other hand, is expected to accelerate considerably to 4.6%, according to the RBI. Yet, the MPC was correct not to raise rates since most of the inflationary pressure is due to supply issues rather than demand conditions. Raising rates would not only have slowed growth further, but even the primary objective of containing inflation would not have been met. A lot of factors need to play out before monetary policy can act — the war, the U.S. tariff-related investigations, greater clarity on a potential El Nino impact on the monsoon this year, to name a few. Until then, inaction is the best course of action.
- 1The Reserve Bank of India's Monetary Policy Committee (MPC), constituted under the RBI Act, 1934, plays a crucial governance role by formulating monetary policy to ensure price stability and support growth. Its recent decision to hold the repo rate unchanged, despite inflation forecasts, showcases its function of using policy instruments to manage economic volatility caused by external factors, thereby balancing its dual mandate in a complex global environment.
- 2Geopolitical events, such as the conflict in West Asia and disruptions in the Strait of Hormuz, directly impact India's domestic economic stability by creating supply chain constraints. The RBI's cautious monetary policy reflects how international relations and global trade security are critical variables in national economic decision-making. This illustrates the intricate link between foreign policy challenges and the domestic policy responses formulated by institutions like the MPC.
- 3The RBI's decision to hold the repo rate has a significant economic and social impact, as it directly influences loan costs for consumers and investment capital for businesses. By not raising rates, the MPC aims to avoid stifling GDP growth, which it projects at 6.9%, while acknowledging that current inflation is supply-driven. This policy stance affects household spending power, industrial output, and overall economic sentiment in the country.
- 4Environmental factors, such as a potential El Niño event, are critical variables in India's economic forecasting and policy formulation. A weak monsoon caused by El Niño can severely impact agricultural output, leading to food inflation and affecting the overall Consumer Price Index. This demonstrates how the RBI's Monetary Policy Committee must consider scientific and climatic projections when assessing future inflationary pressures and deciding on interest rate actions.