Monetary policy in 2026 is all about liquidity

The Reserve Bank of India (RBI) has already delivered 125 basis points of cuts in 2025, including an outsized 50 bps move last June. The easing cycle has now given way to possibly an extended pause, even as the central bank works aggressively behind the scenes to keep the system flush. Since December, the RBI has deployed a string of open market operation (OMO) purchases and forex swap auctions, attempting to offset the liquidity drag caused by slow deposit growth, foreign capital outflows, and persistent intervention to stabilize the rupee. This shift is deliberate: with global yields hardening and domestic credit growing faster than deposits, the central bank’s priority has moved decisively from lowering the repo rate further to preserving transmission of earlier cuts.

Why liquidity matters more than the rate

The February policy will reinforce that shift. Based on current estimates, the RBI may need to conduct ₹2 trillion of OMO purchases over the rest of FY26 and another ₹4 trillion in Q1 FY27 to ensure durable liquidity remains above 1% of net demand and time liabilities (NDTL). The RBI will also continue to rely on variable rate repo (VRR) auctions of varying tenors to keep the overnight call rate aligned with the repo rate. For a central bank intent on maintaining financial conditions supportive of growth, these operations are not technical footnotes-they are the whole story.

For the moment, inflation gives the RBI room to prioritize liquidity. The central bank is expected to retain its 2.0% consumer price inflation forecast for FY26, though the January–March projection of 2.9% may be revised down by 20–30 bps. For FY27, the projection will likely remain at 4.5%. But the more intriguing development comes on 12 February, when India unveils a new consumer price index (CPI) series with updated weights and a fresh base year. With food weights falling from 46% to around 37%, the future inflation trajectory can benefit if food prices were to pick up more than currently anticipated in FY27. It is too early for the RBI—or analysts—to bake this into forecasts, but the shift could modestly reshape the inflation trajectory.

In the near term, headline inflation is expected to rise gradually due to an adverse base, nudging above 4.5% by the December quarter. Yet core inflation remains comfortably subdued near 4%, and below 3.5% when gold is excluded. As RBI governor Sanjay Malhotra noted in the last MPC minutes: “Excluding precious metals, inflation is likely to be much lower… demand pressures are minimal and projected to remain low."

Growth forecasts: the hawkish trap

On growth, the RBI is likely to maintain its FY27 projection at 6.6%. This, too, will be reassessed after 27 February, when India releases a new GDP series with an updated base year and revised methodology. That revision could nudge historical growth—and future potential—slightly higher.

Yet here lies a potential twist with market implications:

If the RBI were to raise its FY27 growth forecast to 7% or above, in line with the recent Economic Survey estimate of 6.8-7.2%, while retaining its 4.5% inflation outlook, markets would read this as a hawkish signal. A forward-looking central bank anticipating 7%-plus real growth alongside inflation drifting above target would logically shift towards rate hikes, not cuts. Bond markets are already positioned for this path, pricing in 75 bps of hikes by December 2027, which would take the repo rate to 6%.

DB Research expects the first rate hike in Q2 2027, with a cumulative 100 bps of tightening in FY28, lifting the repo rate to 6.25% by the end of March that year.

The broader challenge: transmission hurdle

Despite a benign inflation outlook and steady growth, the near-term challenge is unmistakable: preventing the tightening of liquidity from undermining the transmission of past cuts. Several forces have made the situation challenging:

Global rate repricing has narrowed India’s space to remain dovish.

The domestic rate-cut cycle seems to be over, with the RBI likely to maintain an extended pause.

A less favourable bond demand-supply dynamic persists, even with fiscal consolidation.

The rupee’s depreciation pressure has forced heavy forex intervention, which drains rupee liquidity.

Given this backdrop, the RBI’s priority must be to ensure that the financial system stays adequately funded and that credit flows are not choked by liquidity scarcity.

What next

Large-scale OMOs will remain a pillar of liquidity support.

VRR operations will continue to stabilize short-term rates.

The MPC will avoid cutting the repo rate further—doing so risks weakening the India-US interest rate differential and discouraging capital inflows.

Communication will need to be measured, avoiding overly bullish growth commentary that could inadvertently tighten financial conditions.

The bottom line

India’s monetary policy narrative in 2026 is not about whether rates move up or down. It is about how much liquidity the RBI will inject to keep the financial system running smoothly, support credit flows, and maintain confidence through a complicated global environment. In this cycle, liquidity isn’t just a supporting actor—it is the headline instrument.

Kaushik Das is chief economist—India, Malaysia, and South Asia at Deutsche Bank AG.