Rate decision and economic assessment

The RBI monetary policy committee (MPC) left the benchmark rate unchanged at 5.25%, along our expectations, while the stance was maintained at neutral. Policy guidance was cautious, as the Governor highlighted tightening global policy conditions, prolonged West Asia crisis, pipeline inflationary risks domestically on higher oil as well as sub-normal monsoon and challenges to the growth outlook.

The MPC pointed to considerable risks to the baseline assessment of inflation and growth due to the uncertainty about the duration and intensity of the conflict, magnitude of its spillover effects and the pace of restoration of supply chains (see data revisions in the table).

Host of measures to boost inflows and support domestic financial markets

The RBI and the government announced a host of coordinated measures to boost inflows and support the capital account math. These ticked all boxes to spur dollar inflows, which is likely to result in reserves accretion and stabilise the currency, signaling all hands are on deck. Ability to attract inflows upwards of $40-50bn will have a meaningful impact on the external balances, with our FY27 BOP estimate at ~$65bn (assuming oil at $85-90bl). 

Highlights included: 

- Expansion of FAR securities: Universe of eligible securities under the Fully Accessible Route (FAR) was widened to include all new issuances of 15Y, 30Y, and 40Y G-secs. In addition, limits pertaining to short-term investment, concentration and individual securities on investment under the General Route were also removed.

- FPI liberalisation: Withholding tax (of 20%) and long term capital gains tax on debt investors into FPI debt will be lifted, thereby drawing in more FPI inflow into Gsecs. This also paves the way for inclusion into other global FI benchmarks as well as adoption into the Euroclear platform. 

- Plans to merge general and long-term investment limits for bonds. 1HFY27 FPI limit at INR 4.6trn and INR 4.8trn for 2H. 

- Boost investment inflows from non-residents: Limits for investment by NRIs and OCIs in equity instruments traded on the stock market without SEBI registration are being increased. This same facility was also extended to all individual Persons Resident Outside India (PROIs). This formalises changes announced by the government in the Budget. 

- Concessional forex swap will be provided till 30th September 2026 to incentivize ECBs by public sector entities. Details on the final pricing is being awaited. Industry watchers peg the share of PSUs in outstanding ECBs at 35-40%. 

- Facility under which full hedging costs will be provided (by the RBI) till Sep26 for Authorised dealers (ADs) to raise fresh 3–5-year FCNR (B) deposits. This scheme mirrors the move back in 2013 (discounted swap; attracted $26bn in deposits and $34bn on wider concessional swap facilities) to draw in non-resident deposits but will necessitate a higher subsidy by the RBI in the context of higher US rates currently vs 2013. Arbitrage is attractive (spread between USD & INR is at ~250bp), despite being lower than past cycle. These will be exempt from CRR/ SLR, and leverage is expected to be permitted. 

- Export realisation timeline: Restored the time for realisation of export proceeds to nine months, from 15 months earlier. This will draw dollar flows by the exporters, helping to make trade-related flows more balanced and limit one-sided pressure on the rupee.

Key takeaways and outlook

The hawkish pause underscored the central bank’s resolve to contain inflationary expectations and defend the currency, while recognizing that tighter policy rates have historically only had a limited impact on exchange-rate dynamics.

If CPI inflation overshoots 5% yoy in FY27 in line with the central bank’s forecast (DBSf: 4.9% - faces upside risks), the current repo rate at 5.25% will narrow the real rate buffer considerably, opening the door to hikes. 

We see room for two hikes, 25bp each in 2HFY27 (from October) when average inflation would have surpassed the mid-point of the 2-6% target and risks of a spillover to demand/ core readings would be material. Liquidity operations are likely to be nimble and two-sided. System liquidity i.e., net position under the LAF stood at an average daily surplus of INR 2.63trn since the April rate review. 

Growth Report

4QFY26 growth accelerated to 7.8% yoy

4QFY26 GDP growth rose 7.8% yoy from a revised 8% in 3QFY26 (Oct-Dec25). Nominal GDP stood at 9.1%. On the supply-side, real and nominal GVA was assessed to have grown by 7.9% and 9.9% respectively in the quarter. 

Quarterly trends: Much of the lift in 4QFY came from strong growth in fixed investments (up 10.8% yoy) and consumption (up healthy 7.1% but slower than 8.2% in 3Q). Household consumption remained the largest component of GDP, with PFCE accounting for 56.7% of GDP in FY26. Supply drivers were dominated by higher service sector output – 9.9% yoy, steady from quarter before. Labour intensive sectors performed strongly, especially trade, hotels etc which was up 12.5% yoy (from 11.2% quarter before), along with financial services 10.4% though moderating from 3Q. 

Annual trend: For the full-year real growth averaged 7.7% yoy, in line with our forecast. GVA growth was firmer at 7.9% from 7.3%. Under real GDP, consumption benefited from firm rural demand on the back of a normal monsoon, direct as well as indirect tax rationalisation, festive lift and easier financial conditions. Pick up in public sector capex, and construction boosted investment growth in the year, while trade performance was mixed but surfacing as a marginal contributor. GVA growth found support from still firm farm (and allied) output at 3.2% yoy despite moderating from the previous year. Secondary and tertiary sector performance led the cart. Under services, mirroring the quarterly trend, labour intensive sector i.e. trade, hotels grew at a strong pace (up 11% yoy vs FY25’s 6.6%) alongside financial services (10.4%). This led full-year GVA to register a sharp 60bp jump between FY25 and FY26 at 7.9%. 

Nominal GDP: Lower deflators led FY26 nominal GDP to slow to 8.9% in FY26 from 9.7% year before. 

Outlook

Markets are likely to move on from the backward-looking data and focus on potential spillover risks into FY27, particularly given the prospect of a prolonged disruption in the supply of critical inputs to downstream industries, higher energy as well as food costs impacting purchasing power and tighter financial conditions. Brent averages are ~40-50% above Jan-Feb26 averages. Informal players especially in the services sector faced supply shortages and higher prices of substitutes, forcing them to curtail operations. Headwinds from El-Nino led shocks also need to be monitored, despite a rising share of irrigated land (India: El Niño’s rain check). 

We maintain our real GDP growth forecast at 6.5% for FY27, compared to RBI’s revised 6.6% estimate. Nominal GDP growth is set to surprise on the upside at 12-13% vs budgeted 10%, cushioning crucial deficit and debt ratios. At the rate review on Friday, policymakers acknowledged downside risks to their baseline growth outlook stemming from uncertainty over the duration and intensity of the conflict. Nevertheless, they are likely to raise interest rates if the inflation outlook evolves in line with the projections presented in their quarterly forecast.