Why in News?

• The Reserve Bank of India (RBI), through its Monetary Policy Committee (MPC), has kept the repo rate unchanged at 5.25% despite rising inflationary pressures stemming from the West Asia conflict, elevated crude oil prices, and global economic uncertainties.
• Simultaneously, the RBI has revised growth and inflation projections and introduced measures to attract foreign capital inflows.

What’s in Today’s Article?

• Reasons for Keeping Interest Rates Unchanged
• Growth Outlook Weakens
• Inflation Risks Intensify
• RBI's Measures to Attract Foreign Capital
• Liberalisation of Foreign Investments
• Greater Access for Overseas Investors
• RBI Governor's Remarks on Indian Economy
• Conclusion

Reasons for Keeping Interest Rates Unchanged:

• The MPC adopted a cautious "wait-and-watch" approach amid increasing uncertainty in the global economy.
• Key reasons:
  • Escalating tensions involving the US, Israel, and Iran have increased risks of higher energy prices, supply-chain disruptions, financial market volatility, and global trade uncertainty.
  • India is also facing capital outflows, pressure on the rupee, and stress on foreign exchange reserves.
• Implications of status quo:
  • Repo Rate remains at 5.25%, the rate at which RBI lends to commercial banks.
  • Lending and deposit rates are likely to remain stable.
  • EMIs on home, vehicle, personal and business loans are expected to remain unchanged.
  • Businesses gain a predictable borrowing environment for investment planning.
  • Borrowers receive relief from any immediate increase in financing costs.

Growth Outlook Weakens:

• RBI revises GDP growth forecast for FY27 from 6.9% to 6.7%. This marks a cumulative reduction of about 100 basis points from earlier expectations.
• Factors behind lower growth:
  • Elevated crude oil prices.
  • Disruptions in global supply chains.
  • Geopolitical instability in West Asia.
  • Financial market volatility.
  • Weather-related disturbances affecting economic activity.
• RBI's assessment: While domestic demand remains resilient and manufacturing and services continue to expand, external shocks are expected to moderate overall economic growth.

Inflation Risks Intensify:

• The Consumer Price Index (CPI) inflation forecast for FY27 has been raised from 4.6% to 5.1%. The revised estimate exceeds the RBI's medium-term inflation target of 4%.
• Drivers of inflation:
  • Rising fuel prices: Retail fuel prices have already increased by around ₹7.5 per litre. Higher crude oil prices may lead to further revisions.
  • Direct impact on inflation: Fuel price increases could add approximately 35 basis points (bps) to headline CPI inflation.
  • Indirect inflationary effects: Transportation and logistics costs may increase. Additional impact estimated at 10–15 bps.
  • Food inflation risks: Heatwave conditions may affect agricultural output and food prices.
  • Producer price pressures: The Wholesale Price Index (WPI) inflation rose sharply to 8.3%, increasing the likelihood of pass-through to consumers.
• Future monetary policy: If geopolitical tensions persist and inflation expectations become entrenched, analysts believe the RBI may consider rate hikes later in the year.

RBI's Measures to Attract Foreign Capital:

• To strengthen external financing conditions and support economic growth, the RBI announced several capital inflow-enhancing measures.
• Concessional forex swap facility for PSUs:
  • Available until September 30, 2026, it is designed to encourage External Commercial Borrowings (ECBs) by Public Sector Undertakings (PSUs).
  • Significance:
    • Reduces hedging and borrowing costs.
    • Enables PSUs in sectors such as oil, power and infrastructure to access cheaper overseas funds.
    • Supports investment and infrastructure spending.
• Incentives for FCNR(B) deposits:
  • The RBI will provide full hedging support for banks mobilising Foreign Currency Non-Resident (Bank) [FCNR(B)] deposits with maturities of 3–5 years.
  • FCNR(B) account:
    • Fixed deposit account maintained by Non-Resident Indians (NRIs) and Overseas Citizens of India (OCIs).
    • Deposits are held in foreign currencies such as USD, GBP, EUR and CAD.
    • Protects depositors from exchange-rate fluctuations.
  • Expected benefits: Banks can offer more attractive interest rates. Increase in stable foreign currency inflows. Improved foreign exchange liquidity. Strengthening of India's external sector.

Liberalisation of Foreign Investments:

• Expansion of Fully Accessible Route (FAR): The RBI expanded the universe of government securities eligible under the FAR.
• Key changes:
  • Inclusion of all new 15-year, 30-year, and 40-year government securities.
  • Removal of restrictions on short-term investments, concentration limits, and individual security exposure for Foreign Institutional Investors (FIIs).
• Significance: Enhances foreign participation in government bond markets. Supports government borrowing programmes. Deepens India's debt market.

Greater Access for Overseas Investors:

• Equity investments: Higher investment limits for NRIs and OCIs in listed equity instruments. Similar benefits extended to all Persons Resident Outside India (PROIs) without mandatory SEBI registration.
• Export promotion: RBI proposes restoring the time limit for realisation of export proceeds to nine months, supporting trade and foreign exchange earnings. 

RBI Governor's Remarks on Indian Economy:

• Indian Rupee is not undervalued:
  • According to the REER, the rupee may actually be overvalued, indicating RBI's preference for avoiding artificial exchange-rate management and maintaining market-based valuation.
  • REER (Real Effective Exchange Rate): Measures a currency's value against major trading partners' currencies after adjusting for inflation, indicating international competitiveness.
• Competition for deposits is healthy: As long as competition remains transparent and fair, it can improve financial intermediation and benefit depositors through better returns.
• Private capital expenditure (Capex) showing improvement: The investment-to-GDP ratio has been rising, suggesting strengthening business confidence.
• Plastic/polymer currency notes under consideration: The central bank is evaluating the costs, benefits, durability, and overall viability before taking a final decision.

Conclusion:

• While holding rates steady protects economic activity amid global uncertainty, upward revisions in inflation forecasts highlight growing price pressures.
• Measures to attract foreign capital seek to strengthen the Balance of Payments (BoP), stabilise the rupee, and improve foreign exchange liquidity in an environment marked by rising geopolitical and economic risks.
• Going forward, sustaining growth while containing imported inflation and ensuring adequate foreign capital inflows will remain central to India's monetary and external sector strategy.