Patience Will Help the RBI Make the Right Call

The Indian economy has exhibited remarkable resilience in April-June, as indicated by the advance indicators. Inflation has undershot expectations during the last quarter by around 30 bps. These are positive developments that formed the backdrop to the August policy meeting. That said, the two months between the June and August policies have seen considerable volatility in oil prices. 

The maximum Brent crude price between June and August was close to $100 a barrel, while the minimum was nearly $71 a barrel. India is critically exposed to crude oil imports, which has led to large fluctuations in the rupee. While we see a pause in the war between the US and Iran and hopes have been rebuilt for a deal, it is difficult to take a firm view on it.

The thought in the initial paragraph clearly illustrates the current complexity of estimating economic variables. It is a challenging task for central bankers across the world to assimilate incoming data and take a view on both growth and inflation. The challenge is magnified for an emerging-market central banker, as policy-rate actions by central banks globally can affect capital inflows into the economy.

The foreign-flow concern has largely been addressed, with the RBI measures announced in the June policy to draw in flows through the FCNR(B), ECB and FCOB routes yielding results. Based on the latest data available from the RBI, total flows due to these measures are close to $41 billion, and total flows into the economy could be in the region of $80 billion-$100 billion, providing the RBI with considerable comfort as it fights another battle on the currency front. But exposure to oil price volatility remains.

The RBI indicated that there is a clear risk that price pressures will rise. It also highlighted that current inflation is mostly supply-driven, mainly by food and fuel, and that there is no immediate evidence of inflation becoming broad-based, as core inflation remains moderate. To the RBI’s advantage, the undershoot in April-June inflation relative to its own estimates reflects limited pass-through of higher input costs by manufacturers, as seen in a widening wedge between WPI and CPI. So far, the pass-through has been mostly in the form of higher fuel prices at the pump.

That said, recent newspaper reports point to manufacturers across sectors preparing to raise product prices. The other risk to inflation is El Niño, but the RBI adds the caveat that, for now, proactive supply management and adequate foodgrain stocks would provide comfort.

The RBI now estimates headline CPI inflation for 2026-27 at 5.0%, down from 5.1% earlier. For the quarters ahead, the July-September estimate has been lowered by 40 bps to 4.7%, the October-December estimate is unchanged at 5.9%, and the January-March estimate has been raised by 10 bps to 5.5%. Our own estimate for July-September is similar to the RBI’s, while our estimates for October-December and January-March are lower.

Importantly, the RBI appears willing to look through the supply-led inflation pressures. Further, there is no clear indication yet whether the inflation pressures are likely to be transitory or more permanent. These considerations are neatly summed up in the RBI’s policy statement: “There is a need for greater clarity to emerge, especially regarding inflation, its path and composition before taking any policy action. Any such policy action would also have to consider the need for recalibration of policy rates in line with the evolving growth-inflation dynamics, especially the normalisation of the underlying inflation from its benign levels seen hitherto.”

The policy stance also remains unchanged at ‘neutral’. During the press conference, the Governor stated that the ‘neutral’ stance is suited to a shallow rate cycle. This could mean that the RBI currently anticipates that any rate-increase cycle, whenever it begins, will be short. Under current circumstances, with no clarity on macroeconomic data, it also means that the RBI remains open to any course of action: a pause, a cut or a hike, as the situation warrants.

It remains difficult to take a view on the October policy. The RBI will see two more inflation prints before the next policy. The intervening period may also bring volatility in oil prices and the rupee, and there will be greater clarity by October on El Niño’s impact on prices, output and consumer demand. Despite the forward-looking inflation estimates appearing high relative to the 5.25% repo rate, the RBI is unlikely to take a pre-emptive decision and risk a policy misstep.

It is well understood that the RBI’s monetary policy remains independent of the monetary policies of large global central banks. But this is no longer certain, as the rate differential between the US and India remains low, and any rate increase by the US Federal Reserve may leave the RBI with little choice but to tighten domestic monetary policy, especially if it leads to another bout of sharp rupee depreciation.

* The views expressed in this article are personal.