The Monetary Policy Committee (MPC) last week decided to keep the policy repo rate unchanged at 5.5 per cent as the nation heads into the festival season with growth and inflation both playing out well though there are many worrying signals in the air. Formally, the mandated objective of the monetary policy in India under the terms of the RBI Act of 1934 is “maintaining price stability keeping in mind the objective of growth”. This is of course managed largely through the instrument of the policy repo rate decided by the MPC. The policy repo rate is in itself critically hinged on the trinity of growth, inflation and liquidity conditions, with the growth-inflation dynamic managed by the MPC and liquidity conditions largely under the ambit of the RBI.
In the present milieu, the broad features of the trinity are: (a) the Indian economy continues to exhibit strength and resilience, (b) at the same time, there has been a considerable moderation in headline inflation, and (c) the system liquidity continues to be in surplus. To begin with a few stylised facts are in order.
On growth, the MPC has recognised the tailwinds in terms of rising capacity utilisation, conducive financial conditions, improving domestic demand, buoyancy in the services sector, steady employment conditions and rationalisation of GST. The headwinds are trickier: ongoing tariff and trade policy uncertainties impacting external demand for goods and services, prolonged geopolitical tensions and volatility in international financial markets caused by risk-off sentiments of investors. However, on balance, the growth outlook remains resilient at present.
RBI’s surveys
Some indicators come from the RBI’s bi-monthly surveys on capacity utilisation, new orders, infrastructure outlook and industrial outlook. These survey results work as lead indicators. They reported that capacity utilisation at 75.8 per cent in Q1 of 2025-26 was an increase of 30 basis points over the corresponding period of the previous year. New order books of manufacturers and sales to inventory remained stable. The industrial outlook survey indicated a positive outlook on demand conditions while cost pressures from raw materials showed signs of moderation. Business expectations index remained steady, and the infrastructure sector expectations were positive on demand and employment conditions.
These are all pointers towards a growth momentum in the economy but this comes with a caveat. Real GDP growth for 2025-26 has been projected at 6.8 per cent, with Q2 at 7 per cent, Q3 at 6.4 per cent, and Q4 at 6.2 per cent. Real GDP growth for Q1:2026-27 is projected at 6.4 per cent. Do note that that the growth momentum as projected is not a steady uptick but moves non-linearly, pointing to pressures and challenges underlying the growth story. This growth is not of the kind that will move because the economy is firing well but demands a nudge if not a push to drive private investments, which must pick up for the momentum to sustain. In the absence of robust private investments, growth can and will sputter.
On inflation, it may be noted that the headline CPI inflation rate declined to its eight-year low of 1.6 per cent (y-o-y) in July 2025 as against the mandated target of 4+/- 2 per cent. But there is a need to look deeper into this. Benign inflation conditions during 2025-26 so far have been primarily driven by a sharp decline in food inflation. Core inflation, however, remained at the much higher level of 4.2 per cent in August 2025. Core remaining higher than headline warrants close monitoring. The MPC has projected headline CPI inflation rate at 2.6 per cent for 2025-26. However, despite substantial moderation in Q2 (1.8 per cent) and Q3 (1.8 per cent), the CPI inflation rate according to MPC will be at 4 per cent in Q4 and 4.5 per cent in Q1 of 2026-27. Thus, there is a sharp upward swing projected, posing special challenges in managing the road ahead in terms of monetary management.
Liquidity management
The third leg of the trinity is liquidity conditions. System liquidity, as measured by the net position under the Liquidity Adjustment Facility (LAF), continued to remain in surplus. For example, it aggregated a surplus amount of ₹1,30,566 crore as on September 26, 2025. It may be noted that as the year passes by, the drawdown of government cash balances and the remaining 75 basis points cut in the cash reserve ratio (CRR) during October-November (October 4, November 1 and November 29, 2025 with a 25 basis points reduction on each occasion, as a result of which the CRR will be 3.25 per cent as on November 29, 2025) will aid banking system liquidity. As the RBI Governor mentioned earlier in June, besides providing durable liquidity of ₹2.5 lakh crore by December 2025, it will reduce the cost of funding of the banks, thereby helping in monetary policy transmission to the credit market.
All of this works as planned only if the delivery of credit from the banking sector and offtake of credit by the private sector are both boosted significantly.
This leads to important questions on the growth and inflation forecast/estimates by MPC and if they are unbiased. These are the forecasts that industry uses to formulate their business plans. Second, has inflation truly been tamed? Inflation forecasts act as the intermediate target for monetary policy under a Flexible Inflation Targeting (FIT) framework. And lastly, how far are the liquidity and credit conditions favourable for private sector to support growth? Will the private sector bite?
A study by the RBI in August 2025 (Discussion Paper on Monetary Policy Framework) concluded that there has been an improvement in the forecasts possibly due to improvement in modelling and “that the use of the forecasts by the MPC does not result in any bias in policy-making, ceteris paribus.”
The current benign inflation rate is primarily on account of substantial moderation in food inflation and deflation in vegetable prices. There will be an uptick in the inflation rate in Q4 of 2025-26 and Q1 of 2026-27 with a persistence of core inflation, by the MPC’s own estimates. Thus, the risks to inflation remain and while the beast looks to be tamed, that is not exactly the right way to read the situation. In view of this, the neutral monetary policy stance by MPC is appropriate.
Surplus liquidity conditions because of the CRR cut and cumulative policy repo rate cut have helped a reduction in the Weighted Average Call Rate (WACR) which is the operating target of the monetary policy and other short-term rates. This in turn will also help reduction in the long-term rates facilitating the smooth operation of monetary transmission. The softer interest rate channel coupled with the recent announcement of the RBI governor with regard to facilitating ease of doing business and foreign exchange management will help the private sector to further speed up their investment, particularly in the manufacturing and infrastructure sector. The S&P upgrades of India’s Sovereign Rating to ‘BBB’ which highlights “strong growth, fiscal stability, and controlled inflation” can help encourage foreign direct investment flows to India, enhancing private investment and pushing the growth momentum.
Overall, a benign inflation rate, the encouraging interest rates scenario and measures to boost investment by the RBI are an opportunity to help build non-inflationary growth in the medium term.
The writer is a former central banker and Professor at the Gokhale Institute of Politics and Economics, Pune. Views are personal. (Through The Billion Press)
Published on October 7, 2025