RBI’s Dovish Turn Clouds the Story of India’s Goldilocks Economy

The Reserve Bank of India extended its narrative of a strong economy and reaffirmed its reflationary stance with a sizeable infusion of durable liquidity and a further 25 basis points reduction in the policy rate. The easing of the repo rate to 5.25% took cumulative rate cuts in the current cycle to 125 basis points, supported by a fresh liquidity injection of ₹1 trillion through government bond purchases and a three-year buy-sell dollar swap worth $5 billion. These additions follow earlier liquidity support through deep cut in cash reserve ratio.

The central bank’s accommodative moves sit alongside an array of earlier regulatory changes designed to revive credit demand. They are also working in tandem with fiscal steps intended to bolster household consumption through income tax and goods and services tax rationalisation. This combined push reflects a policy preference for demand revival rather than confidence in underlying strength.

The central bank described the stronger-than-expected real GDP outcome of 8% in the January–June period of 2025-26 and the accompanying collapse in inflation as a rare Goldilocks combination. The portrayal suggests an economy that is not only insulated from global trade turbulence but also thriving despite it. Official figures show real GDP grew 8.2% in the July–September quarter, supported by resilient domestic demand and broad-based expansion in industry and services. High frequency indicators through the October–December quarter have held up, helped by robust rural demand and a gradual improvement in urban consumption. Growth is now projected at 7.3% in 2025-26, up from 6.8%, with an average of 6.8% expected in the first half of 2026-27.

Inflation fell to an all-time low of 0.25% in October 2025, largely because of food deflation. Core inflation eased to about 4.3%, and after excluding gold, it is closer to 2.6%. The outlook has been revised downwards with headline inflation rising gradually from 2% in the second half of 2025-26 to 4% in the first half of 2026-27. Better food supply conditions and moderating global commodity prices underpin this assessment.

External balances remained stable. The current account deficit narrowed to 1.3% of GDP in the July–September quarter due to services exports and remittances. The merchandise trade deficit widened in October because exports contracted 11.9%. Foreign direct investment inflows strengthened, and reserves climbed to $686 billion, enough to cover more than eleven months of imports.

The benign narrative on growth, inflation, and external balances sits in contrast to the scale of the monetary and fiscal stimulus already underway. Such reflationary force is unusual for an economy that is supposedly in Goldilocks territory, and the contradictions are increasingly evident.

The first inconsistency relates to the Goldilocks claim itself. In macroeconomic parlance, Goldilocks refers to moderate growth, stable inflation, and low unemployment. India’s 8% real GDP growth in the first half of 2025-26 is well above structural norms, a pace achieved only seven times in the fifty-four years before the pandemic. Inflation at around 0.3% is far below the lower bound of the central bank’s target and signals deflationary risk. Unemployment remains elevated with rising joblessness among educated youth. If inflation is genuinely this low, the associated risks span subdued nominal GDP, weak demand, slower wage growth, rising default probabilities, and pressure on government revenues.

A second disconnect lies between strong headline GDP growth and weak underlying demand. Growth of 8% alongside ultra-low inflation is a rare combination. Private consumption, which accounts for about 60% of GDP, reportedly grew 8%, yet consumer goods production rose only 0.8% year on year in the industrial index, down from 2.7%. Consumer companies across staples and discretionary categories reported subdued sales growth, and household surveys by the central bank reflect similar softness. Incremental personal credit growth has slowed except for loans against gold, often a sign of financial stress. The divergence raises questions about whether the GDP numbers accurately capture ground conditions.

The claim of a nascent revival in private capital expenditure is equally difficult to sustain. Capacity utilisation in manufacturing averaged 73.2% in the July–September quarter and was 74.8% in the April–June quarter, both described by the central bank as above long-term norms. Yet utilisation has declined from 77.5% in January–March 2025 despite the surge in real GDP. It is also lower than the 78.4% recorded in 2011-12 when real GDP grew 5.2%. Over the past sixty quarters, utilisation exceeded long-term averages thirty-seven times without triggering a meaningful investment cycle. Corporate balance sheets reinforce this: the ratio of net fixed assets to sales has slipped to 5% in 2024-25 from 7% in 2011-12. Recent cash flow strength has largely been channelled into financial investments and dividends rather than fixed assets.

Inflation as experienced by households tells a different story from the official data. The central bank’s September 2025 survey shows that 90% of households continue to feel the strain of higher living costs, while only 2-5% reporting relief, even though inflation averaged 1.7%. This contrasts with the 2016–17 period, when inflation averaged 4.3% and a larger share of households reported stable or falling prices. The divergence between recorded inflation and lived inflation is significant and further weakens the Goldilocks narrative.

Taken together, the perceived resilience in growth is at odds with the underlying data. Demand remains fragile, and the policy mix is unmistakably counter-cyclical. Fiscal measures such as income tax relief and GST rationalisation accompany monetary easing and regulatory relaxation to stimulate credit. This alignment underscores the authorities’ desire to reflate the economy rather than manage the consequences of strength.

The central bank’s interventions in the government bond market through open market purchases and its dollar swap operations serve several objectives. The immediate aim is to stabilise financial markets amid sustained foreign portfolio selling in equities and a weakening dollar rupee. They also help guide the government bond yield curve lower to support valuations and stem capital outflows. Lower risk-free rates are essential for the government at a time when sluggish tax revenues threaten the fiscal deficit target of 4.4% of GDP.

Whether the reflationary gamble works will depend on transmission. Bank credit-deposit ratios have reached 80.2%, limiting their ability to expand lending if deposit mobilisation remains weak. Government bond yields have hardened despite the latest rate cut because banks face pressure on spreads. The key question is whether liquidity injections through open market operations and foreign exchange swaps can expand money supply and deposit growth without compromising inflation stability or forcing further use of reserves.

The contradictions within the policy stance will shape how durable the current optimism proves to be.