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RBI pauses

The RBI monetary policy committee (MPC) unanimously kept the repo rate unchanged at 5.5%, in line with our expectations. The policy corridor was maintained, with the standing deposit facility (SDF) rate remains at 5.25% while the marginal standing facility (MSF) rate and the Bank Rate remains at 5.75%. While the stance remained at ‘neutral’, two external members cast dissent votes in favour of a change in stance to ‘accommodative’.

The economic assessment was balanced, with the FY26 GDP growth revised up by 30bp to 6.8% yoy, while inflation was lowered by 50bp to 2.6%. Global economy was seen as being resilient, while the MPC cited the strong domestic growth outcome for 1QFY26 (see report). Along our expectations, 2QFY growth is pegged at 7% yoy.

Looking ahead, farm output is expected to benefit from above normal monsoon, good progress of kharif sowing and adequate reservoir levels, boosting rural demand, besides which services sector buoyancy and better investments were viewed as strengths. Tariff and trade policy uncertainties were seen as a risk for external balances, though structural reforms, including streamlining of GST were expected to largely offset these risks.

Besides revising up FY26 growth to 6.8%, 1QFY27 (Apr-Jun26) was projected at 6.4%.

Factoring in the current run-rate and disinflationary impact of GST rationalisation, the FY26 inflation forecast was trimmed. Healthy progress of the south-west monsoon, higher kharif sowing, adequate reservoir levels and comfortable buffer stock of foodgrains were expected to aid food disinflation. The MPC saw the inflation outcome to be softer than the August review, on account of the GST rate cuts and benign food prices. Considering these factors, FY26 inflation was lowered to 2.6% (from 3.1% previously), with 1QFY27 projected at 4.5%. Given the evolving trajectory, we revise down our inflation forecast for FY26 to 2.5% yoy from the current 2.8%.

In the October Monetary Policy Report, (see table above), the underlying economic assumptions are broadly unchanged except expectation of a weaker currency in 2H, besides a slight widening in the general government fiscal deficit in FY26.

Outlook 

Policy guidance was moderately dovish. There were two signs that policy room had opened up. Firstly, the RBI highlighted that “current macroeconomic conditions and the outlook has opened up policy space for further supporting growth.”, suggesting the path ahead will be data dependent. Secondly, the divide in the voting for the stance reflects dovish undercurrents amongst few of the MPC members.

The MPC is likely to be guided by growth rather than inflation. Risks from external developments is likely to subside if there is a successful trade deal between the US and India. We include one rate cut to our trajectory for rest of FY26 to a terminal rate of 5.25%, with a move likely in December. Policymakers might opt to undertake open market operations to restrain bond yields/ SDLs rather than utilise monetary policy levers.

We expect 10Y yields to head towards 6.3% by end fiscal year. Our end-2025 INR FX projection is for the USDINR to return below 88.00, premised on further US dollar correction, central bank’s intervention, and signs of material progress on trade negotiations with the US. Notably, the rupee remains at competitive levels on real terms, with the INR REER hovering at 98-100 in recent months. 

Host of regulatory measures

The RBI announced a host of favourable regulatory changes on Wednesday (press release), spanning moves to ease credit standards, lower risk weights for lending for NBFCs as well as infra sector besides simplifying the ease of doing business. We highlight a few here:

In a positive move for banks, the scope of the capital market exposures of the regulated entities was broadened for capital market lending by banks and other regulated entities. Thereby, an enabling framework will be provided for banks to finance acquisitions by Indian corporates, besides enhancing the limit for lending by banks against shares, units of REITs, units of InvITs while removing the regulatory ceiling altogether on lending against listed debt securities. Guidelines are expected to be released separately.

Risk Weights on infrastructure lending by NBFCs. In a move to rationalise risk weights for infrastructure lending by NBFCs in line with the nuanced risk-profile of operational projects, it has been decided to introduce a principle-based framework.

Relaxation in compliance requirements for Small Value Exporters/Importers. In a bid to lower compliance cost for smaller value exporters/importers, it was decided to simplify the process of reconciliation in Export Data Processing and Monitoring System (EDPMS) and Import Data Processing and Monitoring System (IDPMS).

Further strengthening the rupee internationalisation mechanism, the RBI took steps to promote the settlement of cross border transactions in INR and local currencies, by allowing Authorised Dealer banks in India and their overseas branches to lend in INR to persons resident in Bhutan, Nepal, and Sri Lanka, including a bank in these jurisdictions, to facilitate cross border trade transactions. Separately the Financial Benchmark India Limited (FBIL) will expand the currency list to include all of India’s major trading partners to deepen the onshore FX market. Lastly, INR Funds in the Special Rupee Vostro Accounts (SRVA) basis of the July 2022 changes, can be invested in corporate bonds and commercial papers.

Small tweaks to the revised liquidity framework

In a separate development, the RBI finalised the revised liquidity management framework after discussions within the Internal Working Group (IWG) and financial industry stakeholders. As the IWG report released in August noted, the economy had witnessed significant changes since this framework was introduced, including a wider usage of digital payments, just-in-time release of funds towards centrally sponsored schemes etc. and operationalisation of a 24x365 payments system. Add to this capital flows had injected volatility, for instance, dollar inflows, if left unsterilised have influenced systemic liquidity and rates.

Against this backdrop, there were minimal changes to the existing mechanism, with the main contours as follows: 

The overnight weighted average call rate (WACR) will continue to be the operating target of the monetary policy. There were few recommendations to move to alternative benchmarks including TREPS (Triparty Repo), though the RBI opted for status quo on this front, adding that they will take other money market rates to ensure stability. The IWG had noted that WACR and rates in the overnight collateralised segments (Triparty Repo and Market Repo) displayed a high degree of correlation among them and are in close alignment across time horizons.

Policy corridor rates remain unchanged. The existing symmetric corridor system is retained, with policy repo rate at the middle of the corridor and standing deposit facility (SDF) and marginal standing facility (MSF), which are 25bps on either side of the policy repo rate, acting as the lower bound (floor) and upper bound (ceiling) of the corridor, respectively. A wider range could be introduced for intraday volatility, while a narrower range could lower the incentivise for banks to particate in inter-bank trading.

Lastly, the 14-day variable rate repo (VRR)/ variable rate reverse repo (VRRR) operation will be discontinued as the main operation for managing short-term/transient liquidity. Instead, the 7-day VRR/ VRRR and other VRR/VRRR operations of tenors from overnight up to 14 days might be utilised, at the discretion of the central bank. The IWG had highlighted challenges faced by banks in forecasting the liquidity position for a 14-day period and resultant lower participation, hence suggesting shorter tenor operations.

Cash reserve ratio requirement has also been retained at 90% daily.

See table in Annex for the various liquidity facilities under the revised framework.

Slower transmission of bank lending rates, lifts non-bank funding

In FY26, non-food credit growth has slowed to 10.5% yoy in 1QFY26 (excluding merger), compared to full year FY25 at 14%. This deceleration reflects broad-based slowdown amongst the verticals, with industry moderating to an average of 6% yoy in 5MFY26, compared to 8.3% in FY25. This was led by 2.0% yoy growth in loans to large enterprises vs 6.4% in FY25, that form bulk of the book. By contrast, lending to micro and small as well as medium enterprises has improved sharply to average 17% and 15% respectively in 5MFY26.

Loans to service sectors and personal loans, which make nearly three-fifth of overall disbursements grew 16% yoy and 17.6% respectively in FY25 (excluding merger impact). These segments have slowed into FY26, on the back of risk weight adjustments by the central bank to rein in unsecured, non-banks and microfinance loans. Few of these restrictions have since been eased to provide a fillip to demand and encourage banks to boost credit growth.

Slowdown in banks’ loan growth does not provide the full picture on credit availability and demand. With the transmission of rate cuts lagging amongst banks (especially those on MCLR benchmarks), part of the demand has shifted to markets-based borrowings, i.e., onshore as well as external commercial borrowings. To recall, of the outstanding floating rate rupee loans (~75% of total gross advances), the share of EBLR (external benchmark lending rate) vs MCLR (Marginal cost of funds lending rate) stood at 60.6% as of Dec-24 vs 35.9% for MCLR. The ratio of EBLRs is higher in private banks vs nationalised banks.

Market-based borrowing costs had compressing quite sharply in 1H25, encouraging part of the demand to migrate to non-bank sources. In FY26 yet far, in response to cumulative 100bp of cuts in the repo rate, the WACR, the 3-month T-bill rate, the 3-month CP issued by NBFCs, and the 3-month CD rate declined by 92 bps, 105 bps, 118 bps, and 147 bps, respectively (link) by last week of September 2025. By comparison, the Marginal Cost of Fund Based Lending Rate (MCLR) overnight rate eased by 45bp to 8% by late-Sep25 vs Dec24.

Despite slower bank lending growth, the total flow of financial resources to the commercial sector continued to be cumulatively higher in FY25 vs year before (link) – see chart below. In FY26, the total flow of resources from non-bank sources to the commercial sector increased by INR 2.66trn more than offsetting the decline in non-food bank credit. Among the non-bank sources, issuances of corporate bonds by non-financial entities increased by INR 1.7trn while net inward FDI increased by INR 0.93trn. In 1QFY26 alone, bond market issuances rose to INR 3.4trn from 2.1trn same quarter year before. Commercial paper issuances by non-financial entities in 1QFY rose to INR 780bn from INR300bn.

In the RBI’s assessment, commercial banks remained in good health, with the system-level Capital to Risk Weighted Assets Ratio (CRAR) of 17.5% in June 2025 well above the regulatory minimum level. NPL ration stood at 2.2% in Jun25 vs 2.7% in Jun24. Net Interest Margin (NIMs) were at 3.25% for Jun25 (vs 3.5% in Jun24). NBFC Parameters puts the CRAR at 25.7% and Tier I CRAR was 23.8% well above the minimum regulatory requirements. GNPA ratio has improved to 2.2% in Jun25 (vs 2.5% in Jun24).

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