On October 1, the Reserve Bank of India (RBI) made a pivotal decision to maintain its benchmark policy interest rate at 5.5% for the second consecutive monetary policy meeting. This choice reflects the RBI’s strategic response to a landscape of global uncertainties, including tariffs that pose threats to the Indian economy, a depreciating rupee, and the critical need to sustain a delicate balance between economic growth and inflationary pressures.
Since the beginning of 2025, the RBI has implemented a cumulative 100-basis-point reduction in policy rates aimed at stimulating economic activity. However, despite these cuts, commercial banks have been slow to pass on the full benefits to their customers owing to various reasons, as illustrated by the lingering 58-basis-point gap in the rates on new loans. This situation suggests that, although policy rates have been held steady, banks still have the potential to lower their lending rates further to enhance access to credit.
In a proactive measure to support lending, the RBI has signalled its willingness to inject additional liquidity into the banking system if necessary. This could involve a reduction in the Cash Reserve Ratio (CRR), which requires banks to hold a fraction of their deposits in reserve with the RBI. By lowering the CRR, banks would have more capital available to extend loans to businesses and consumers.
Recent data released by the Reserve Bank highlights that banking credit expanded by 9.5% during the quarter ending in June, while deposits demonstrated a slightly stronger growth of 10.1% year-on-year for the same period. This relatively subdued credit growth has been largely attributed to the negative impacts on both investment and consumption patterns observed in the first half of the financial year, particularly during the critical summer sowing and monsoon seasons. Furthermore, the broader banking sector experienced a decrease in credit growth to 12% in the financial year 2025, a notable decline from the previous year’s growth rate of 16%, driven by faltering demand.
In a significant reform aimed at enhancing the stability of the banking sector, the Deposit Insurance and Credit Guarantee Corporation (DICGC) has historically imposed a uniform premium rate of 12 paise for every Rs . 100 deposited across all banks since 1962. This approach has not differentiated between financially robust banks and those facing challenges. To rectify this, the RBI plans to implement a risk-based premium model starting in the next fiscal year. Under this new framework, well-capitalized banks will benefit from lower premiums, while weaker banks will incur higher charges. This strategy is designed to alleviate costs for sound banks, enabling them to channel more capital into lending, while simultaneously incentivizing struggling institutions to bolster their financial health. This initiative by the Reserve Bank aims to bolster the safety of public deposits and fortify the overall resilience of the banking system.
Moreover, the central government’s efforts to rationalize the Goods and Services Tax (GST) are anticipated to have a positive multiplier effect on the economy, enhancing savings, consumption, demand, supply, and overall economic activity. In a notable financial development, India’s foreign exchange reserves have reached an impressive milestone of US$700.2 billion, a level sufficient to cover imports for approximately 11 months. This robust reserve position is expected to help sustain the current account deficit at manageable levels in the current fiscal year and support the government’s initiatives in navigating challenges stemming from US tariffs.
Despite facing challenges such as tariffs and ongoing fluctuations in the value of the rupee, India’s external trade sector remains remarkably resilient. In an effort to further bolster this sector, the Reserve Bank of India has proposed that Nepal, Bhutan, and Sri Lanka engage in rupee lending transactions for cross-border trade. This initiative aims to encourage the adoption of rupee-denominated trade practices, thereby enhancing regional economic integration. Furthermore, the central bank plans to facilitate investments in various financial instruments, including corporate bonds and commercial papers, with the aim of deepening liquidity and investment opportunities in the market.
The Consumer Price Index (CPI) inflation is projected to remain subdued in August, primarily due to the reduction in GST rates, coupled with easing food prices. In light of this favourable environment, the Reserve Bank has revised its inflation forecasts for the fiscal year 2025-26, decreasing the estimate from 3.1% to a more optimistic 2.6%. Likewise, for the second quarter, the inflation forecast has been adjusted downwards from 2.1% to 1.8%, and for the third quarter, from 3.1% to 1.8%. Nevertheless, the central bank anticipates that retail inflation will rise to 4% by the fourth quarter, with a projection of 4.5% for the first quarter of FY 2026-27.
Presently, core inflation stands at a stable 4.2%, a figure indicating that the underlying price pressures within the economy are largely manageable. Overall inflation levels appear to be contained, with headline inflation declining from 3.7% in June to 3.1% in August. This controlled inflation environment is expected to significantly support economic growth and may facilitate the Reserve Bank’s decision to lower policy rates in forthcoming monetary policy evaluations. Also, this reduction could lead to lower bank lending rates, an increase in bank borrowings as the festive season approaches, and a general stimulation of economic activity.
In a recent report, the Organisation for Economic Co-operation and Development (OECD) raised India’s GDP growth forecast, increasing it by 40 basis points from a prior estimate of 6.3% to 6.7% for 2025. This upward revision is attributed to strong domestic demand and the positive impacts of GST reforms. Conversely, the Asian Development Bank has adjusted its growth outlook for fiscal year 2025-26 to 6.5%, despite recording an impressive 7.8% GDP growth in the first quarter. This adjustment stems from concerns over the ramifications of tariffs. Nevertheless, many economists maintain an optimistic perspective, arguing that GST reforms have the potential to facilitate monetary easing, bolster domestic demand, invigorate economic activity, and ultimately enhance GDP growth.
Amidst these dynamics, the growth rate of industrial production has decelerated to 4% year-on-year in August, predominantly due to a slowdown in the manufacturing sector. However, expectations of increased festive demand alongside the positive effects of GST reforms provide a hopeful outlook for future growth in this area.
In summary, the decision to keep the repo rate unchanged reflects a strategic response to the pressures of US tariffs and the depreciation of the rupee, while simultaneously striving to maintain a judicious balance between fostering growth and controlling inflation. The Reserve Bank has also preserved the option to inject additional liquidity into the banking system through changes to the CRR if deemed necessary. This approach underscores the central bank’s commitment to safeguarding economic stability. Additionally, the recent monetary policy review introduced new measures aimed at strengthening the rupee by promoting rupee-denominated trade with neighbouring countries and recalibrating the DICGC premium, ultimately seeking to create a more robust and resilient economy.
Satish Singh is a Senior Columnist based in Mumbai, and the opinions expressed in the article are personal.
