RBI's neutral stance signals higher tolerance for inflation, delays rate hike prospects: SBICAPS

The Reserve Bank of India's (RBI) decision to keep the policy repo rate unchanged at 5.25% while retaining its "neutral" policy stance marks a shift in its approach to interest rates, suggesting greater tolerance for elevated inflation and reducing the likelihood of a rate hike in FY27, according to a report by SBICAPS.

The Monetary Policy Committee (MPC) left the repo rate unchanged at 5.25%, along with the Standing Deposit Facility (SDF) and Marginal Standing Facility (MSF) rates. Retaining the neutral stance assumes significance as the MPC had earlier indicated it would use the stance to signal the future trajectory of interest rates.

SBICAPS noted that with consumer price inflation (CPI) projected to remain at or above 5% through the first quarter of FY28, the real policy rate is expected to hover around zero for several months. This marks a departure from the RBI's earlier preference for maintaining significantly higher real interest rates. While the next policy move is still expected to be a rate hike, the Governor's commentary suggests that such action has been pushed further into the future, making a hike in FY27 less likely.

Inflation outlook

The report highlighted that retail inflation crossed the RBI's 4% target in June 2026 for the first time in 17 months, reflecting the delayed pass-through of higher wholesale prices to consumers. Although the RBI Governor maintained that second-round inflationary effects remain absent, SBICAPS said rising food prices and volatile crude oil prices are already influencing the central bank's inflation projections.

The RBI marginally lowered its FY27 inflation forecast to 5%, primarily due to lower-than-expected inflation in the first quarter and expectations that favourable base effects from precious metals will moderate core inflation in the final quarter of the fiscal year.

According to the report, the RBI now appears more willing to tolerate higher headline inflation while focusing more closely on underlying core inflation trends.

Growth outlook remains positive

SBICAPS said high-frequency indicators such as industrial production, automobile sales and bank credit growth point to a strong start for the domestic economy in the first quarter of FY27.

The revival in bank lending to large industries also suggests that the long-awaited private capital expenditure cycle may be gaining momentum. Reflecting these trends, the RBI raised its FY27 real GDP growth forecast by 10 basis points to 6.7%. However, the report cautioned that the upward revision largely reflects stronger-than-expected recent data rather than improved prospects for the second half of FY27. Risks from geopolitical tensions and a weaker-than-expected monsoon affecting rural demand continue to warrant close monitoring.

External sector strengthens

The report said coordinated measures by the government and the RBI have significantly improved external sector stability.

Between June 8 and July 31, 2026, India mobilised $40.8 billion through special external financing measures, including $36.7 billion in FCNR(B) deposits, $2.6 billion through Overseas Foreign Currency Borrowings (OFCBs), and $1.5 billion in External Commercial Borrowings (ECBs).

Net foreign direct investment (FDI) inflows rose 64.6% year-on-year to $7.9 billion in the first quarter of FY27 while foreign portfolio investment (FPI) flows also improved as the fiscal year progressed.

SBICAPS said these developments have reduced balance of payments risks and could support further stability, or even appreciation, of the rupee against the US dollar.

Liquidity to remain actively managed

The report said the RBI maintained surplus liquidity during the inter-policy period while conducting frequent Variable Rate Repo (VRR) operations to prevent excess liquidity from fuelling inflation.

The central bank reiterated its commitment to ensuring adequate liquidity in the banking system to keep the weighted average call rate (WACR) aligned with the policy repo rate. However, the RBI Governor indicated that liquidity conditions may become less comfortable after September 2026.

Bond yields likely to remain range-bound

SBICAPS expects benchmark government bond yields to remain largely range-bound, although competing domestic and global factors could trigger volatility.

Factors that may push yields higher include delays in India's inclusion in the Bloomberg bond index, renewed geopolitical tensions in West Asia and a high fiscal deficit. Conversely, softer core inflation, improving FPI inflows into debt and equity markets, robust FCNR(B) deposit inflows and currency stability are expected to support bond prices and cap any sharp rise in yields.