The Reserve Bank of India (RBI) did exactly what almost every RBI watcher expected this week. It left the repo rate unchanged. The decision was unanimous. By the time the announcement arrived, financial markets had already moved on to the RBI governor’s explanation.
That reasoning was what gave economists something to get their teeth into. Inflation has been edging up for five consecutive months and remained above RBI’s 4% target since June. Yet, the Monetary Policy Committee (MPC) sounded more dovish about the outlook than many economists had expected.
The immediate reason is easy enough to identify. Consumer price inflation during the first quarter of 2026-27 came in below RBI’s own forecast. Core inflation is subdued too. The committee’s judgement is that inflation is rising without becoming broad-based. RBI believes it will peak later this year without breaching its tolerance limit of 6%.
That assessment may prove correct. Equally, it may not. Surveys suggest that inflation expectations are firming up, as the MPC itself noted in its previous meeting. Much therefore turns on RBI’s inflation projections. Yet there are good reasons to be cautious about them. Geopolitical disruptions and recurring global shocks have all made that forecasting unusually difficult.
RBI lowered its inflation projection for 2026-27 marginally. Even so, its forecast implies inflation above 5% for three successive quarters (5.9% in the third quarter of 2026-27, 5.5% in the fourth and 5.3% in the first quarter of 2027-28). It also raised its 2026-27 growth forecast from 6.6% to 6.7%, with the governor noting at the post-policy conference that 7% was “not inconceivable.”
The interesting question, then, is not whether RBI should have raised rates this week. The more revealing question is why almost nobody expected it to.
Expectations of a central bank’s moves are formed less by reading policy statements than by observing what they repeatedly do. Every MPC says it balances inflation against growth. Markets pay closer attention to what committees actually do when those objectives are in conflict.
Over time, a fairly settled view of RBI has emerged. It is widely seen as an institution that prefers to wait rather than tighten policy unless inflation becomes impossible to ignore or external developments leave it with little room for manoeuvre. That reputation did not arise from this meeting. It has been accumulating over several years.
The inflation shock that followed Russia’s invasion of Ukraine is part of that record. Like several central banks abroad, RBI initially thought inflation would be transitory. As prices continued to rise, policy remained largely unresponsive. The eventual tightening came only after the US Federal Reserve had begun raising interest rates, and in an unscheduled meeting that caught markets by surprise.
RBI never suggested that exchange-rate considerations had influenced its decision. It did not have to. The timing led many observers to conclude that protecting the rupee had become at least as pressing an aim as containing domestic inflation.
That episode changed expectations of how RBI approaches tough trade-offs. There are other reasons those expectations have hardened. During the pandemic-time inflation surge, the MPC appeared willing to tolerate inflation above the limit prescribed under its inflation-targeting framework.
Official price statistics had been disrupted during covid lockdowns, so the government did not make RBI’s explanation for the breach public. The central bank may have consequently escaped much scrutiny, even though the underlying inflation trend was evident from other indicators.
None of this proves RBI has given up inflation targeting. Nor does it imply that this week’s decision was an error. What it does suggest is that markets observe central banks pursuing several objectives and infer a hierarchy among them.
Conversations with market participants reveal a recurring concern that is expressed more in private than in public. Many investors would describe the hierarchy roughly as: exchange-rate stability, government’s borrowing costs, growth and finally inflation. Whether RBI itself would recognize such a priority order is beside the point. Once markets begin to believe it, the perception acquires economic significance of its own.
That view influences not only expectations of the next policy decision, but also how markets interpret every inflation reading and communication from the MPC. The coming weeks may offer an early test of that perception. The Fed will meet again in September, ahead of RBI’s October policy review. The MPC may well decide by then that inflation warrants higher rates. Many market participants expect the Fed’s decision to shape RBI’s room for manoeuvre as much as domestic inflation.
The MPC may well decide that inflation warrants higher rates by then. Whether that expectation proves right is less important than the fact that it has become part of the market’s reading of RBI. That may explain why this week’s decision felt less like a close call than a foregone conclusion. Inflation has been rising and inflation expectations are showing signs of firming up.
Yet, very few analysts bet on a rate hike. They have come to believe they know how RBI reacts under such circumstances. Monetary policy works through expectations. So, increasingly, does RBI’s reputation.
The author is senior fellow (consultant), Indian Council for Research on International Economic Relations.