- The Reserve Bank of India cut its repo rate by 25bps to 5.25% in a unanimous vote in the December 2025 meeting, while also keeping its neutral policy stance unchanged.
- Overall, RBI remains modestly dovish in the meeting, committed to providing sufficient INR liquidity, and did not push back against INR weakness in the press conference.
- We as such remain comfortable in our view for USD/INR to rise modestly above the 90 levels over time, targeting the 90.80 levels by the September quarter, and implying continued INR weakness against key FX crosses such as EUR, JPY and CNY (see IndiaPulse – What ails INR? Balance of payments remains unbalanced). This assumes a trade deal between US and India is struck by early 2026, bringing tariffs down to 25% from 50%.
- If a trade deal between US and India is not eventually struck however, we may well see USD/INR rise towards the 92 levels.
- We see RBI keeping the repo rate on hold from here at 5.25% and see RBI likely at the end of the rate cut cycle.
Key details:
- The consensus expectation was very split ahead of the meeting, and we were expecting RBI to delay its rate cut to the February 2026 meeting given the strong real GDP print and uncertainties around the pace of INR weakness.
- RBI also announced INR liquidity injections totalling around INR1.4 trillion, made up of OMO purchases of government bonds worth INR1 trillion and also a 3-year FX buy/sell swap of US$5bn. Our sense is that OMO purchases were expected by the market, but the buy/sell swap was probably not.
- Overall, RBI Governor Sanjay Malhotra committed to providing sufficient INR liquidity moving forward, even as he emphasised that the repo rate remains the key operating target and not government bond yields. With these measures, we saw some declines in FX forward implied yields after earlier spikes, lower G-sec yields with some steepening in the yield curve.
- Of course, there is no free lunch in life.
- On our end, we heard nothing suggesting pushback to INR weakness from the RBI Governor during the policy meeting, with sanguine comments about the path ahead for the current account deficit and capital inflows, driven by goldilocks of low inflation and strong growth. The stated focus by RBI continues to be on managing FX volatility, while not targeting any specific USD/INR level based on the press conference.
- We think RBI might be too sanguine on the outlook for India’s external balances.
- As we have highlighted, the widening in India’s current account deficit comes at a time when foreign capital inflows has dried up significantly, both on portfolio inflows and also in net FDI through higher gross FDI repatriation (see IndiaPulse – What ails INR? Balance of payments remains unbalanced). Historically, India has been a growth market, and as such the capital account is typically more important than the current account in determining whether strong growth can be financed through stronger inflows.
- The big change that we have been highlighting since the start of the year has been a swing in the net FDI position to essentially zero right now from US$40bn annualised a few years ago, with elevated gross FDI repatriation a key driver as foreigners such as Private Equity funds continue to take profit on existing investments given the valuation gap between India and other markets.
- To some extent, the marginal flow we see in USD/INR right now could potentially be attributed to FDI repatriation, beyond changes in foreign portfolio inflows (see IndiaPulse – What ails INR – Balance of payments remains unbalanced).
- Whether this drying up of capital inflows is structural or cyclical remains to be seen, but as we highlighted in our recent report India’s balance of payments remains unbalanced based on our projections. Importantly, we are already assuming a trade deal between US and India bringing tariffs down to 25% from 50%, and as a corollary some forecasted improvement in portfolio inflows.
- At what level of INR weakness would induce capital inflows, and when it could compress the current account deficit will also be key for INR moving forward, given the time lags with which exchange rates transmit through to fundamentals.
- Net-net, we remain comfortable with our view for USD/INR to rise modestly above the 90 levels, targeting the 90.80 levels by the September quarter, and implying continued INR weakness against key FX crosses such as EUR, JPY and CNY. This assumes a trade deal between the US and India is struck by early 2026 bringing tariffs down to 25% from 50%.
- With RBI remaining modestly dovish today and not pushing back against INR weakness, this gives us more confidence directionally.
- We are however not overly bearish on INR at current levels given much cheaper FX valuations, coupled with stronger momentum for structural reforms which could over time unlock the binding constraints to growth. As such, we think FX vols should remain contained.
- If a trade deal between US and India is not eventually struck however, we see the risk for USD/INR to rise towards the 92 levels.
- We see RBI keeping the repo rate on hold from here at 5.25% and see RBI likely at the end of the rate cut cycle.
