RBI rewards ‘goldilocks’ phase with another rate cut, more seen on horizon

The one sore point has been the currency that has weakened sharply by over 5 per cent in 2025, breaching the 90-per-dollar mark this week. But even if economists think this bout of depreciation is much-needed, it is not a monetary policy headache.

“There were many temptations on the path of inflation targeting — the temptation to target the rupee, to target deposit rates, to target growth, but by delivering a 25 bps cut at a time when inflation is well below the RBI’s lower tolerance bound of 2 per cent, the RBI has wisely stuck to its core mandate,” said Aurodeep Nandi, Nomura’s India Economist.

The decision to cut the repo rate — taking the total quantum of easing in 2025 to 125 bps — is also crucial from the perspective of policy consistency. “We would be hiking rates and sounding hawkish if inflation were to run higher than 6 per cent for 6 months. In the same vein, if inflation runs lower than 2 per cent for 6 months, RBI should cut rates and sound dovish,” HSBC economists led by Pranjul Bhandari said in a note.

The RBI is mandated to target an inflation rate of 4 per cent in the medium term in a symmetric band of 2-6 per cent.

More rate cuts likely

An interest rate cut on Friday was made difficult after GDP data released last week showed the Indian economy grew at an unexpectedly high rate of 8.2 per cent in Q2FY26. After the unanimous interest rate decision, the reduction in the RBI’s FY26 inflation forecast to 2 per cent, and Malhotra’s “tactically smart and flexible forward guidance”, economists are penciling in another rate cut in February.

“Importantly, while acknowledging repeated headline undershoots, the Governor also conceded that underlying price pressures are even more subdued,” said Madhavi Arora, chief economist, Emkay Global Financial Services.

The Indian public seems to be of a similar opinion. According to the RBI’s latest inflation expectations survey, released Friday, households’ expectations of inflation three months and one year down the line have fallen sharply by 50 bps and 70 bps, respectively. At 7.6 per cent, households’ three-months-ahead inflation expectations are the lowest in eight years; the one-year-ahead expectation of 8 per cent is the lowest in 6.5 years.

Economists are also convinced growth will moderate in the second half of FY26 for myriad reasons ranging from less expansive government expenditure and the 50 per cent US tariff on India’s exports taking a toll. Malhotra conceded as much saying “growth, while remaining resilient, is expected to soften somewhat”. The RBI’s latest forecast sees GDP growth falling sharply to 7 per cent and 6.5 per cent in October-December and January-March 2026, respectively.

The rupee problem

If growth and inflation have not been an issue for Malhotra, the exchange rate is a different case altogether. The rupee’s recent travails did not feature at all in the RBI Governor’s statement. Several attempts by reporters at the briefing later were batted away, including with humour (“I think you people don’t have more questions”). Rejecting suggestions that the RBI has consciously become more tolerant to exchange rate volatility, Malhotra said the markets are deep and efficient, that “fluctuations, this volatility, does happen”, and that the RBI will continue to reduce any abnormal or excessive volatility.

Whatever the Governor might say, the RBI’s exchange rate management has undergone a sea-change under Malhotra. Even the International Monetary Fund has taken note of this, changing its de-facto assessment of India’s currency exchange rate system to ‘crawl-like arrangement’ from ‘stabilised’. Greater exchange rate flexibility “would be helpful for absorbing external shocks”, it said.

Economists think the rupee battle is one the RBI does not need to engage in. It remains to be seen whether the growth-inflation ‘goldilocks’ period will continue even after the Statistics Ministry launches the new GDP and retail inflation series in February 2026.