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Monetary Policy in a Low-Inflation Environment: RBI’s Growth–Inflation Balancing Act

With core inflation subdued and capacity utilisation stable, the MPC debates the scope for calibrated easing while maintaining price stability.
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Surya
••5 mins read
RBI keeps policy rate unchanged, supports growth amid benign inflation outlook.
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1. Policy Decision and Overall Context

The Reserve Bank of India’s (RBI) six-member Monetary Policy Committee (MPC) unanimously decided to keep the policy repo rate unchanged in its February 2026 meeting. The decision was taken against the backdrop of a benign inflation outlook and stable growth conditions.

The minutes reveal that most members expressed support for prioritising growth, given that inflationary pressures appeared contained. However, only one member, Ram Singh, preferred a shift in stance to accommodative, indicating internal nuance within broad consensus.

The discussion reflects the RBI’s flexible inflation-targeting framework, where price stability remains the primary mandate, but growth considerations influence stance when inflation risks are subdued.

Monetary policy credibility depends on maintaining inflation control while responding to growth dynamics. If growth-supportive signals are given without anchoring inflation expectations, macroeconomic stability could be compromised.

2. Inflation Outlook: Headline vs Core Dynamics

Governor Sanjay Malhotra emphasised that inflation is projected to remain benign, consistent with earlier projections. He highlighted the importance not only of headline inflation but also of its composition.

“In terms of the overall trajectory, inflation, as projected earlier too, is expected to remain benign.” — Sanjay Malhotra, RBI Governor

Precious metals were noted to contribute 60–70 basis points to inflation, artificially elevating headline numbers. Underlying inflation, excluding precious metals, remains lower.

Deputy Governor Poonam Gupta pointed out that core inflation (excluding precious metals) stood at 2.3% (December 2025) and is expected to remain benign in the next two quarters (April–June and July–September 2026–27).

Key Indicators:

  • Core inflation (Dec 2025): 2.3%
  • Precious metals impact: 60–70 bps
  • Headline CPI projected near target in H1 2026–27

Distinguishing between transient price shocks and underlying demand-driven inflation is essential. Failure to do so may result in premature tightening or excessive easing, both of which can destabilise growth.

3. Growth Conditions and Capacity Utilisation

India’s growth rate remains above 7%, and some MPC members see scope for acceleration towards 8%, in alignment with the broader “Viksit Bharat” vision.

Capacity utilisation was reported at 74%, suggesting that the economy is not operating at overheating levels. This implies limited demand-pull inflation risk in the near term.

External member Ram Singh noted that the economy may be entering a structural phase where 7%+ growth and moderate inflation can coexist.

“Filtering out the effect of increases in precious metal prices… the underlying inflation pressures are expected to remain muted.” — Ram Singh

When capacity utilisation remains below stress thresholds, monetary easing may not immediately trigger inflation. However, misjudging output gaps can lead to delayed responses if demand accelerates sharply.

4. Divergent Views within the MPC

Although the repo rate was kept unchanged, internal views varied regarding future policy direction.

Ram Singh suggested that the easing cycle may not have concluded and supported a more growth-oriented stance, depending on incoming data.

Nagesh Kumar argued that benign inflation provides policy space to support growth acceleration from around 7% to 8%, complementing fiscal policy.

However, Saugata Bhattacharya cautioned that risks of future inflationary pressures were accumulating, though household inflation expectations remained anchored. Indranil Bhattacharyya emphasised that the updated CPI weighting diagram would offer clearer insights into inflation trends.

Divergence Highlights:

  • Majority: Growth-supportive bias
  • One member: Favoured accommodative stance
  • Caution: Risks of future inflation pressures

Diversity of views strengthens institutional decision-making. Ignoring emerging risks while focusing solely on current benign data could undermine medium-term price stability.

5. External Sector and Trade Developments

Governor Malhotra referred to recent trade deals with the European Union and the United States, suggesting that they could strengthen exports, improve the current account balance, and attract investment.

Improved trade prospects can ease external sector pressures and support growth without necessarily triggering inflation. Stronger exports and capital inflows may also provide exchange rate stability.

This reflects the interconnectedness of monetary policy (GS3) and international economic relations (GS2/IR).

External stability complements domestic monetary space. However, over-reliance on external demand without domestic resilience may expose the economy to global shocks.

6. Monetary Policy Framework and Data Evolution

Members noted that the new CPI data series, with an updated consumption basket, will provide greater clarity on inflation dynamics. This improves the quality of monetary transmission and policy calibration.

The RBI continues to operate under a flexible inflation-targeting regime, targeting headline CPI while considering underlying trends and expectations.

Indranil Bhattacharyya highlighted that with headline inflation below target in 2025–26 and projected near target in early 2026–27, the current policy rate and neutral stance allow flexibility.

Institutional Features:

  • Six-member MPC
  • Flexible inflation targeting
  • Neutral stance provides policy flexibility

Data accuracy and updated consumption weights are critical for effective inflation targeting. Without reliable measurement, policy calibration may misalign with actual economic conditions.

Conclusion

The February 2026 MPC minutes indicate a cautious but growth-supportive monetary stance amid benign inflation. With core inflation at 2.3%, capacity utilisation at 74%, and headline inflation projected near target, policy space appears available.

However, internal caution regarding emerging inflation risks underscores the importance of data-driven flexibility. Sustaining high growth while preserving price stability will require calibrated monetary responses aligned with evolving domestic and global conditions.

Quick Q&A

Everything you need to know

The decision to keep the policy repo rate unchanged while maintaining a neutral stance reflects the RBI’s attempt to balance growth and inflation concerns. A neutral stance implies that the Monetary Policy Committee (MPC) retains flexibility to either tighten or ease rates depending on incoming data. It signals caution rather than a definitive shift toward monetary easing or tightening.

In the present context, headline inflation remains benign, and core inflation—excluding volatile components such as precious metals—has been subdued at around 2.3%. At the same time, GDP growth has exceeded 7%, and capacity utilisation stands at 74%, indicating no immediate signs of overheating. Thus, the RBI appears confident that inflation is under control while still preserving policy space to support growth if necessary.

This approach underscores India’s flexible inflation-targeting framework, where price stability remains the primary mandate, but growth considerations are not ignored. By maintaining neutrality, the RBI ensures macroeconomic stability while complementing fiscal efforts aimed at achieving the broader goal of sustained high growth under the Viksit Bharat vision.

The composition of inflation is crucial because monetary policy affects different components of inflation unevenly. RBI Governor Sanjay Malhotra highlighted that while headline CPI is targeted, the drivers of inflation matter. Precious metals such as gold and silver contribute 60–70 basis points to inflation, yet their prices are often influenced by global factors and investment demand rather than domestic consumption patterns.

If inflation is driven primarily by volatile or imported factors like precious metals, tightening monetary policy may have limited effectiveness. In contrast, core inflation—reflecting demand-side pressures—is more responsive to interest rate changes. The current data shows core inflation excluding precious metals at a benign 2.3%, indicating subdued underlying demand pressures.

Therefore, analysing inflation composition prevents overreaction to transient shocks. It allows the RBI to maintain a growth-supportive stance without compromising price stability. This nuanced approach enhances policy credibility and ensures that rate decisions are evidence-based rather than mechanically tied to headline figures.

Capacity utilisation, currently at around 74%, indicates that the economy is operating below full productive capacity. When utilisation levels are moderate, it suggests that firms can increase output without significant cost pressures, thereby reducing the risk of demand-pull inflation. This supports the argument that high growth—above 7%—can coexist with moderate inflation.

Equally important are inflation expectations. Saugata Bhattacharya noted that household inflation expectations remain anchored. Stable expectations reduce the risk of wage-price spirals and help maintain macroeconomic stability. If households and businesses believe inflation will remain low, their pricing and wage decisions are less likely to trigger sustained inflationary pressures.

Together, moderate capacity utilisation and anchored expectations provide policy space for the RBI to remain growth-supportive. These indicators act as forward-looking signals, enabling the MPC to calibrate rates prudently while safeguarding credibility under the inflation-targeting regime.

The argument that India is entering a structural phase of high growth with moderate inflation is rooted in improved macroeconomic fundamentals. Structural reforms such as GST, insolvency reforms, digitalisation, and infrastructure expansion have enhanced productivity and supply-side efficiency. This can allow higher growth without proportionate inflationary pressures.

However, risks remain. External shocks—such as commodity price volatility, geopolitical tensions, or global financial tightening—can disrupt this balance. Moreover, supply-side constraints in food or energy sectors can quickly translate into headline inflation spikes. Thus, while current data suggests coexistence is feasible, it is contingent upon stable global conditions and continued domestic reforms.

From a policy perspective, this structural shift would justify a calibrated easing cycle to push growth toward 8%, as suggested by some MPC members. Yet prudence demands vigilance. Sustained coexistence requires continuous monitoring of core inflation, fiscal discipline, and credible policy communication.

The RBI Governor noted that recent trade deals with the European Union and the United States could strengthen exports and attract investment. Improved export performance enhances the current account balance and boosts foreign exchange inflows, thereby stabilising the rupee and reducing imported inflation risks.

For instance, stronger export earnings can offset capital outflows or reduce pressure on foreign exchange reserves. Stable external balances allow the RBI greater flexibility in monetary policy, as exchange rate volatility and imported inflation are key considerations in rate decisions.

Thus, external sector developments directly influence the inflation-growth balance. Successful trade agreements not only promote economic growth but also expand the central bank’s policy space. This case illustrates the interconnectedness of trade policy, external stability, and domestic monetary management in an open economy like India.

Attribution

Original content sources and authors

MS
Manojit Saha
BS
Business Standard
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