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Markets are divided as we approach the RBI monetary policy committee (MPC) rate decision on Friday, in midst of conflicting signals – a strong 8.2% yoy real growth print in 2QFY, while inflation slipped below the policy target to a series low in Oct25 and stayed subdued in Nov-Dec. The policy decision will be dictated by the weightage that the MPC assigns to below-target inflation, which has left a sizeable real rate buffer, or the firm growth report. Our base line view is for a modest cut this week on the back of an evolving inflation trajectory for FY26 which is not only running 50-60bp below the RBI’s projection but has also undershot the 2-6% inflation target band. Admittedly, rupee’s sharp move this week has injected uncertainty into the rate decision. Equal importance will be given to the policy guidance, where the MPC might leave the door open for further action if external conditions deteriorate further, preventing a re-hardening in borrowing costs. While the rupee depreciated to a record low this week, the committee is expected to refrain from providing directional cues on the currency, instead emphasizing on the preference to minimise volatility and discourage one-sided speculative bets. Announcements on potential open market operations might be made outside of the rate decision timeline.
The rupee depreciated to a record low on Wednesday, slipping past the psychologically key 90/$ (down more than 5% YTD). In the past fortnight, the central bank’s strong presence across spot, forwards and the NDF markets had prevented a break in the USDINR past 89.00, drawing a de facto line in the sand. However, the swift move past 90/$ this week could be interpreted as a shift in the response function to allow the unit to find its new equilibrium to better reflect underlying macro shifts. The need to maintain the currency at competitive levels stems from a delay in the US-India trade deal, unfavourable tariff differentials at this juncture, weak equity portfolio flows and a broader focus on manufacturing/ exports. Maturing forward positions have added to the momentum on the flows front, besides upward move in NDFs and importers’ dollar demand. The currency is in undervalued territory on real effective exchange rate basis, as it slipped further below 100 in Oct25 (-9.7% since Nov24). This is occurring at a time when a narrow current account deficit has lowered the reliance on foreign flows compared to the taper tantrum period, although we expect the balance of payments to register a small deficit in FY26. Moreover, a benign oil price outlook and low inflation levels have lowered the risk of an immediate pass-through through imported channels. With the currency in unchartered territory and evolving macro developments, there is scope for further USDINR upside. On geopolitics, Russian President Putin is in India on a state visit, for the 23rd India-Russia Summit, with the likelihood of further collaboration on defence, energy, and space innovation, etc. on the cards. 
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