India's Low Inflation and the Looming Case for RBI Rate Cuts in 2026

India's economic landscape in late 2025 is marked by a rare confluence of low inflation and robust growth, creating a compelling case for further Reserve Bank of India (RBI) rate cuts in 2026. With headline consumer price index (CPI) inflation projected to remain below the RBI's 4% target for the 10th consecutive month in November 2025, and GDP growth forecasts revised upward to 7.3% for fiscal year 2026, the central bank faces mounting pressure-and opportunity-to ease monetary policy further according to data. This analysis explores the implications of these developments for strategic asset allocation in equity and debt markets, drawing on recent policy shifts, inflation trends, and market responses.

A Goldilocks Scenario: Low Inflation and Strong Growth

The RBI's December 2025 monetary policy decision, which cut the repo rate by 25 basis points to 5.25%, underscored the central bank's confidence in the economy's "Goldilocks period" of stable prices and strong growth.

This rate cut followed a cumulative 100-basis-point reduction in earlier months, reflecting a proactive stance to support liquidity amid easing inflation. Core inflation, excluding volatile food and fuel components, stood at 4.2% in September 2025, well within the RBI's 2%–6% target range. Analysts project CPI inflation to average 2% for FY2025–26, a stark contrast to earlier estimates of 3.1%, driven by improved supply conditions and GST rate cuts.

The RBI's upgraded GDP growth forecast to 6.8% for FY2025–26 and 7.3% for FY26 highlights the economy's resilience, fueled by robust public capital expenditure and private sector investment according to the PIB report. This dual tailwind-low inflation and high growth-creates a favorable environment for further rate cuts, as the central bank seeks to balance liquidity management with growth support.

Forward Guidance and Analyst Projections for 2026

The RBI's forward guidance in December 2025 emphasized a "neutral" policy stance, but analysts anticipate additional easing in 2026. Economist Dipanwita Mazumdar of Bank of Baroda forecasts a repo rate of 5% by calendar year 2026, aligning with global trends as the U.S. Federal Reserve reduces rates. Similarly, Garima Kapoor of Elara Securities expects a 50-basis-point cut, citing easing inflation and strong public investment as key enablers. However, CareEdge Ratings cautions that the RBI may prefer to pause and preserve policy flexibility amid external risks, such as U.S. tariffs and potential rural demand shocks.

Projected inflation trends further support the case for rate cuts. The RBI anticipates quarterly CPI inflation of 0.6% in Q3 FY26, 2.9% in Q4 FY26, and 4.5% in Q1 FY27, all within its target range. With food and beverage prices entering deflationary territory, the central bank has ample room to ease policy without compromising inflation control.

Equity Market Implications: Sectoral Opportunities and Risks

Historically, RBI rate cuts have catalyzed equity market rallies by lowering borrowing costs and boosting corporate earnings. The December 2025 rate cut, for instance, spurred broad-based gains across the Nifty and Sensex indices, with mid- and small-cap stocks attracting strong buying interest. Sectors such as real estate, banking, and automotive-highly sensitive to interest rates-are expected to benefit disproportionately from further easing.

However, external uncertainties, including U.S.-India trade tensions and global liquidity shifts, could temper market optimism. The rupee's record low against the dollar, driven by foreign outflows, highlights the vulnerability of Indian equities to external shocks according to market analysis. Investors should prioritize sectors with strong domestic demand and low import dependence while maintaining a diversified portfolio to mitigate risks.

Debt Market Dynamics: Yields, Liquidity, and Policy Tools

The RBI's aggressive liquidity injections-via open market operations (OMO) and FX swaps-have significantly impacted bond yields. By December 2025, the central bank had purchased Rs 3.16 trillion in government securities, pushing the 10-year bond yield down to 6.60%. These measures, combined with repo rate cuts, have softened yields across the curve, making bonds more attractive as fixed-income allocations.

Historical data reinforces this trend: repo rate cuts in 2000–2003 and 2007–2009 led to bond yield declines of 576 and 169 basis points, respectively. While the current easing cycle may not replicate such magnitudes due to global trade uncertainties, the RBI's liquidity-focused OMOs suggest continued downward pressure on yields. Investors should favor long-duration bonds and high-quality corporate debt to capitalize on the yield environment.

Strategic Asset Allocation Recommendations

Given the RBI's projected rate cuts and the current economic climate, a strategic asset allocation should balance growth and defensive positions. For equities, overweight sectors like banking, real estate, and infrastructure, which benefit from lower borrowing costs. For debt, prioritize long-duration government bonds and investment-grade corporate debt to lock in yields before potential rate hikes in 2027.

However, investors must remain vigilant about external risks. A portion of the portfolio should be allocated to short-term instruments or hedged against currency volatility, particularly as U.S. monetary policy and trade dynamics evolve. Additionally, monitoring rural demand and fiscal developments will be critical, as these could influence the RBI's policy trajectory in 2026.

Conclusion

India's low inflation and strong growth have created a favorable backdrop for further RBI rate cuts in 2026. While the central bank's forward guidance suggests a measured approach, the economic fundamentals and historical precedents point to additional easing. For investors, this environment offers opportunities to rebalance portfolios toward growth-sensitive equities and yield-advantaged debt, tempered by a cautious stance on external risks. As the RBI navigates this Goldilocks period, strategic asset allocation will be key to capitalizing on the evolving landscape.