Is the Indian economy a victim of RBI/govt policy mistakes?

· Taylor’s modified rule indicates the RBI should keep the terminal repo rate around 3.0% rather than 5.0%.

·       Decades of higher (often double-digit) borrowing/funding costs and high indirect/consumption taxes, including elevated energy costs, have affected overall Indian economic productivity.

·       Now, almost all of India is under one party (BJP) ‘Double Engine Sarkar/Govt.' Both policymakers and politicians have to act prudently for the ‘Viksit Bharat' developed India aspiration by 2047-50.

In June '26, the RBI adopts a hawkish hold stance amid concerns about transitory hotter CPI inflation, some moderation in economic growth, and a largely stable employment/labor market, at least officially. The RBI may continue to be in neutral (wait & watch) mode till at least December '26. Although the RBI and the government are taking various regulatory measures, including tax concessions, to boost FPI/FDI inflows into the country, these are largely symptomatic & reactive in nature rather than addressing the core issues for the longer term. These are largely cyclical reforms rather than structural. Now, after progress on the US-Iran MOU/deal and some correction in USD/INR, RBI Governor Malhotra came forward and almost assured/pacified the market that the RBI is not in a rush to hike rates in 2026 amid transitory hotter inflation and stable, but not solid, economic growth.

Now the vital question is whether the RBI/Govt. intends to cut rates further by ~200 bps in 2027-28 in a calibrated manner to keep the longer-run terminal rate at ~3% or hold for 5% as usual?

India needs significant reform on the ground for ease of doing business, traveling, and living. India is a high-cost economy—from the extremely high cost of borrowings to taxes (GSTs, tariffs, and various indirect and also direct taxes). Indian people pay much higher taxes (almost 20% of GDP) in terms of return from the government, like free/universal quality education, healthcare, and infrastructure. India has had higher and longer interest and taxation rates for the last several decades. This, along with too many regulations and rampant corruption at government levels (administrations/bureaucrats and politicians/political parties—all are vying for a 20-40% cut of money), is why there are various reasons for the growing net outflow in FDIs.

Big Indian business houses and HNIs are now vying for external investments and permanent citizenship, while foreigners are shying away from/leaving India. Investors are facing various regulatory hurdles in India, including land, labor, and law. This, along with a high cost of living, a weak labor market, and tepid real wage growth— Overall discretionary consumer spending is weak, and thus private capex is still muted. The Indian growth story was traditionally too dependent on uncounted black money (corruption) and government consumption.

India’s government employees and pensioners are one of the big pillars of India’s ‘resilient’ domestic consumption story, but there are too many government employees with huge pay packages (as a result of pay commission-led inflation-adjusted pay hikes over the last few decades), resulting in poor productivity and inefficiencies. Most of the government employees now earn much more than their underlying productivity and private employees do. This is creating wage inflation and overall poor economic productivity; below-average real GDP growth has resulted in a higher cost of living.

India’s so-called demographic dividend may be now turning into a demographic 'cockroach nightmare’ due to huge unemployment/underemployment, especially among educated urban youths. Huge government spending/fiscal stimulus by the government may be preventing the economy from an all-out visible recession at the cost of fiscal prudence and consistent devaluation of the LCU (INR). The INR is now looking like 'toilet paper. India is an autocratic democracy involving a ‘vote bank’ (helicopter/dole money for almost 55% of the population) and a ‘note bank’ (political funding by corporates through cut money funding)—the country is now looking like a ‘banana republic.'

Indian discretionary consumer spending is too dependent on unaccounted/corrupted/cut money and also on government employees to some extent due to huge/unreasonably high salary packages compared to average Indians in the private sector. All these are making RBI’s monetary policies largely ineffective and inefficient for the last few decades. Overall, India’s economic productivity is much lower than the real GDP growth—resulting in higher headline inflation. Indian policymakers & politicians should focus on improving the overall productivity and quality of employment in the economy rather than too much obsession with GDP growth numbers.

India’s legacy issue of higher food inflation is purely a supply-side issue (huge demand from a 1.5B population), and the RBI can’t keep them starving by trying to reduce demand through rate hikes. Similarly, higher fuel costs/inflation is also a supply-side issue arising out of too much taxation by the government.

The Indian federal government is now paying around 45% of core tax revenue as interest on public debt, which is normally a sign of a bankrupt company/economy. India needs to reset completely from politics to economics. India needs to abandon the policy of vote banks & note banks, cut money/corruption, and ensure proper policies are in place to encourage private capex and quality jobs to improve the overall employment situation of the country and the productivity of the economy.

India’s core CPI (w/o food, beverages, fuel, and precious metals) continues to hover around 2.0% and is projected to be around 2.5% in FY27 on average in the worst-case scenario. The headline unemployment rate may be around 6.5% on average (official MOSPI/PLFS 5.5% + CMIE 7.5%), while actual under/unemployment (U6) may well be in the mid-double digits (~25%), and educated youth un/underemployment rate may be around 45%. Indian core real GDP (private consumption + private Capex) needs to grow at least 10.0% in real terms with higher economic productivity for maximum and inclusive employment. India also needs to focus on modern education from primary levels with a focus on innovations (R&D) to compete with mighty China.

For all these, the RBI/Government needs to keep the real positive rate at a true neutral level of +1.0% from the average/projected core CPI (w/o food, fuel, alcohol, and precious metals), which is now hovering around 2.0% and may hover around 2.5% in FY27. India’s core inflation is way below 4.0% targets by at least 200-150 bps, while the headline unemployment rate, around 6.5%, needs to go down by around 200-250 bps to 4.5-4.0% levels. Thus, the RBI needs to cut or ensure a much lower terminal rate around 3.50%-3.00% (1.0% real positive from core CPI) to bring core inflation up (from 2.5% to 3.0%) and employment down back to target (from 6.5% to 4.0%-4.5%).

Taylor’s modified rule indicates the RBI should keep its repo rate around 3.00% rather than 5.25% (at present) to keep supercore CPI at around 3.0% (from 2.4%) and the average unemployment rate at ~4.5% (from 6.5%), assuming a 1.50% core real positive rate the RBI intends to keep. RBI’s official dual mandate should be 2.0-3.0% supercore CPI and a 4.0-4.5% maximum unemployment rate rather than too much obsession with GDP. The government/MOSPI should ensure credible/proper super core CPI and unemployment data.

Both the RBI and the government are making a primary policy mistake by keeping core real rates substantially higher at around 3.5-4.0% along with the higher cost of energy and higher cost of living. As a result of decades of economic & policy mismanagement, it’s little wonder that the INR is fast becoming toilet paper. The natural devaluation rate may accelerate now to 5% and even 10%; USDINR may surge 25-50% over the next 10 years. This, along with potentially higher external borrowings as a result of FPI/GSECs' tax recalibration, may also face FX vulnerability in the coming years.

The short-term gain may turn into long-term pain if Indian policymakers and politicians fail to manage the currency and the economy properly. India needs to have proper policies in place to make the economy much more productive, innovative, and competitive to be a truly developed country by 2047-50; otherwise, it may continue to find itself under the fragile five rather than the fastest five in the true sense (GDP/capita).

The Indian economy has both structural and cyclical issues. The government has to fix both rather than chest-thumping about the ‘world’s fastest-growing major economy. 'The government needs to publish proper core inflation data (w/o food, fuel, and precious metals) along with the employment situation of the country; otherwise, policymakers may continue to drive the economy in the dark without headlights. The Indian government and central bank rarely admit any deficiencies with the domestic economy. They always blame cyclical external shocks like the Iran war, the double blockade of the Strait of Hormuz, COVID, the Ukraine war, etc., and use these triggers as lame excuses for their economic mismanagement. If everything were so fine, then why would NIFTY EPS CAGR continue to hover around 10%, just in line with nominal GDP growth? If nominal GDP indeed grows around 10%, Nifty EPS should also grow by around 15-20% on average.

Conclusions

To make Indian products globally competitive, India needs lower borrowing/funding, energy, and tariff costs/lower costs of raw materials along with massive deregulation. Thus, the RBI/government needs to keep the terminal repo rate at 3.00%, irrespective of any economic & political narrative. The government/MOSPI should officially publish credible core inflation (w/o food, fuel, and precious metals) data and an employment situation report (including fresh job creations in the private sector every month—like the US BLS/JOLTS).

Like the US Fed, the government should give the RBI a dual mandate of maximum employment and price stability (core CPI target) rather than maximum economic growth (real GDP) and price stability (total CPI target). The federal government should also ensure structural reform in labor, land, and law (3L) as the BJP is now in over 80% of Indian states. The government should ensure a minimum wage equivalent to $300-500/M or $10-25/day, if not hours, for an inclusive labor market. A small middle-class family (household) of 3-4 now requires at least $1000-1200/M for a basic, comfortable life in India, whereas average private-sector jobs yield around $300-500/M.

Indian banks & financial institutions (NBFCs) are the biggest beneficiaries of higher interest rates and higher NIM (Net Interest Margin), while borrowers, especially MSMEs and households (retail), are the biggest losers. The federal government, being the promoter/largest shareholder of PSU Banks (PSBs), is also one of the biggest beneficiaries in terms of shareholders' returns (dividends, disinvestment, etc.). Together with the RBI and PSBs, the Indian government now gets almost ₹3.2 trillion in FY26 (RBI ₹2.9T + PSBs ₹0.3T).

The RBI/government kept Indian borrowing/indirect tax rates too high for too long, resulting in poor economic productivity and lower-than-potential economic growth and a subdued labor market/employment situation in the country. The Indian economy should grow by at least +10.0% (double-digit) for the next 25 years along with a +12% productivity rate to ensure inclusive & maximum employment and a developed economy.

Although the RBI is now talking more about core CPI inflation (w/o food, fuel, and precious metals), officially it's targeting total CPI inflation, which often comes around +200 bps higher because of volatile food, fuel, and also precious metals (gold & silver). This is resulting in a higher core real interest rate (RBI REPO), which is now around +2.7% (Avg. repo rate 5.25% - 2.6% Avg. super core CPI); in 2025, the core real RBI REPO rate was around +3.4%. If we compare India’s 10Y bond yield average rate of around 6.8% with the super core CPI AVG of 2.5%, the core real bond yield would be around 4.3% (6.8-2.5%), substantially higher than peer China (REPO rate now at 3.00%; 10Y bond yield +1.75%; core CPI 1.2%).

As a result of higher borrowing costs for decades after decades, the Indian federal government is now paying almost 45% of core tax revenue as interest on public debt. This is a sign of bankruptcy and the resultant higher money supply (printing)—M2 (~₹80T) and huge public debt (~300T combined) and consistent trade deficit (despite huge remittances by NRIs)—the INR is now looking like 'worthless toilet paper.'

Bottom line

Indian politicians and policymakers now must act prudently to rectify their decades of policy mistakes in order to become a truly developed economy by 2047-50, especially since almost all of India is now under the ‘Double Engine Sarkar.'

Technical outlook: Gift Nifty and USDINR

Looking ahead, whatever the narrative may be, technically the Nifty Gift Future (CMP: 24088) now has to sustain over 24300 for a further rally to 24500/24750-24850/24950 and only sustain above 25050, further to 25250/500-25800-26100/26500 in the coming days; otherwise, sustaining below 24250/24200-24000/23700, the Gift Nifty may further fall to 23500/23100-23300/23000 and 22500/22300-22000/21800 and 21500-21000 in the coming days (base-best case scenario).

Similarly, USDINR (94.35) now has to sustain over 94.00-93.50 for a recovery to 95.00-97.50 for a further rally to 100/105-107/110 in the coming days; otherwise, sustaining below 93.50, it may again fall to 93.00*/92.50 in the coming days.

Disclaimer: 

• I have no position or plan to have any position in the above-mentioned financial instruments/assets within the next 72 hours.

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• Please always consult with your personal financial advisor and do your own due diligence before any investment/trading in the capital market.

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