RBI’s 25 bps rate cut marks rare policy shift as inflation hits historic lows: SBI Ecowrap

In a rare policy move, the Reserve Bank of India’s Monetary Policy Committee on December 5 lowered the repo rate by 25 basis points to 5.25%, even though the economy recorded strong GDP growth above 8.2% and consumer inflation fell to 0.25%.

According to the latest Ecowrap report by SBI Research, the MPC’s unanimous vote signals its determination to stay ahead of emerging global uncertainties while continuing to support domestic growth. The position remains neutral, as the Standing Deposit Rate (SDF) has been revised to 5.00% and the Marginal Deposit Rate (MSF) and Bank Rate have been revised to 5.50%. The credit risk ratio remains at 3.0%.

Inflation expectations have fallen significantly

Given low food inflation, strong kharif production, healthy rap farming, and comfortable reservoir levels, the Reserve Bank of India sharply cut inflation forecast for FY26 to 2.0%, down from 2.6% expected in October.

• The inflation rate in the third quarter of fiscal year 2026 is expected to reach 0.6%.
• Q4 FY26 by 2.9%
• Q1 FY27 and Q2 FY27 by 3.9% and 4.0%, respectively.

SBI Research expects inflation to average 1.8% in FY26 and 3.4% in FY27, indicating further downside risks ahead.

Growth forecasts have been updated

The Reserve Bank of India (RBI) has revised India’s real GDP growth forecast for FY2026 to 7.3%, with third-quarter and fourth-quarter growth expected at 7.0% and 6.5%. However, SBI research is more optimistic. GDP is expected to exceed 7% in both the third and fourth quarters, with FY26 growth pegged at 7.6%.

Liquidity management

System liquidity remained in surplus during this fiscal year, despite sharp fluctuations during September and October. To ensure smooth transmission of interest rate cuts, the Reserve Bank of India announced two important interventions:

1. OMO Purchases: Perpetual liquidity infusion of Rs 1 lakh crore in two tranches of Rs 50,000 crore each on December 11 and 18
2. USD/INR Buy-Sell Swap: A three-year USD 5 billion swap is expected to generate an infusion of Rs 45,000 crore. It aims to manage rupee volatility as the currency recently breached the Rs 90 mark per US dollar before recovering

The report notes that the rise in forward insurance premiums for the National Development Fund indicates higher hedging costs amid global volatility. The swap is expected to cushion Mifor prices, reduce hedging costs, and support borrowing from abroad.

The exceptional nature of the interest rate cut

SBI research highlights the unusual nature of interest rate cuts amid high growth and low inflation, noting that such instances are rare globally. Historical parallels from the UK, Indonesia and China show that interest rate cuts only occurred when inflation levels were well above India’s current 0.25%.

The banking system is stable and well capitalized

The report says that India’s banking sector remains healthy.

• Credit Growth: 11.3% YoY (as of October 31, 2025)
• Deposit growth: 9.7%
• GDP ratio improved to 2.05%
• Capital adequacy: 17.24%

The transmission of the cumulative 100 basis point rate cut since February 2025 has been broad. Interest rates on new loans fell by 69 basis points, while interest rates on new term deposits fell by 105 basis points.

Markets must remain ‘unrushed’

The report warns that while the Reserve Bank of India has provided policy support for sustainable growth, financial markets must show maturity and avoid overreacting, especially as uncertainty over tariffs and global risk aversion sentiment may impact external demand.

The SBI research concludes that with inflation expected to fall further in FY27, this may not be the “end of Santa Claus sentiment”, but the central bank has “made every effort” to ensure policy remains strongly supportive of growth.