The Unending Uncertainty

On a foggy road, you drive with your parking lights on, waiting for better visibility. Once you get it, you don’t accelerate to cover lost ground. You still tread slowly, especially when you can see more fog at some distance. That, to my mind, is the backdrop of monetary policy setting even in August, having gone through thick clouds of uncertainty during the April and June meetings. Between the June 5 policy meeting and now, we have seen a ceasefire, its violation, the Strait of Hormuz opened and then closed, free and then chargeable again, oil at $71.5 a barrel and then at $85. Amid these swings, the best thing to do, in our view, is to do nothing. 

We are aware that June CPI inflation rose to a higher-than-expected 4.4%; July could be even higher — WPI and PPI inflation rose further to 9.8% and 9.6%, respectively, and yes, RBI’s Monetary Policy Committee is a flexible inflation targeter. The keyword to my mind here is ‘flexible’. 

Three things became very clear from the minutes of the June MPC meeting:

 1) “The chances of a policy mistake remain heightened given the two-way risks on the inflation-growth outlook.” (June 2026 assumed oil at $95 a barrel);

 2) The inflation shock is still primarily supply-led, as core CPI inflation, adjusted for precious metals, even for June, was at 2.5%; and 

3) “Flexible inflation targeting is a framework best characterised as constrained discretion, in which monetary policy is anchored to a numerical target but retains the scope to accommodate shocks.”

Add to this Governor Malhotra’s recent media interview, calling it ‘premature’ to talk about hikes at this stage of the policy cycle. The signalling here is clear: the rising inflation impulse for an inflation-targeting central bank makes a solid case for imminent hikes, but responding to such deviations, which may be fleeting or not entrenched, can prove to be a costly policy misstep. It’s not to say that RBI MPC won’t hike rates, but it won’t hike for now and all through 2026 in our view. 

Turning to the growth part of the story, the resilience is remarkable indeed. For such a large oil-importing country, an oil price and availability shock of this magnitude would have presumably impacted growth in a more generalised manner. 

However, credit where due, the government’s prompt and well-thought-through policy response, including invoking the Essential Commodities Act, cutting the special excise duty on petrol and diesel, increasing the tax on petrol and diesel exports, and tapping into alternate supplies, has together helped in keeping the crisis concentrated and contained. 

That said, growth will slow this year from a stellar 7.7% in 2025-26 for well-known reasons: El Niño’s impact on agricultural output, lower-than-budgeted government expenditure, foregone excise duty revenues and a higher subsidy bill weighing on the fiscal math, and a lack of any obvious policy stimulus, which supported growth last year. 

So, higher inflation and slowing growth, a 180-degree turn from the ‘Goldilocks’ environment we experienced pre–February, imply a 180-degree turn in policy outcomes? Not as yet.

As inflation tests the upper limit of the RBI’s band in October-December, the clamour for an immediate hike is set to grow. But it’s important to bear in mind the unfavourable base effect at play here—October 2025 CPI inflation printed 0.04%, and the October-December average was 0.6%. Also, isolate the pump price hike in petrol and diesel and the import duty hike in gold, together adding about 30-35 bps to the headline. To add to this, we can’t entirely dismiss the possibility of a partial rollback of petrol and diesel price hikes by then, should global crude oil prices move forward—December Brent contract at $79 a barrel—removing some overhang from quarterly inflation prints. 

So, if MPC is okay to look through this, why hike at all? As the fog settles, the economy reprices higher costs, margin compression for corporates is behind us, inflation genuinely breaches the 4% target, we expect the first hike in February 2027, with the balance of risks in favour of further delay to April and see 50 bps of hikes in January–June 2027, with a 4.7% CPI inflation forecast for 2027-28. 

If they have to hike then, why not now? Too much uncertainty still – an energy shock has growth implications apart from inflation ramifications. Responding to the latter in a rush may cloud assessment of the former. As this settles, hopefully, hiking rates while maintaining a 1% real rate looks about right, and hence the 50 bps hike estimate.

El Niño and Hikes
El Niño will affect rainfall, sowing and potentially harvests. But buffer stocks for rice and wheat may prevent this potential supply shock from translating into a price shock. Latest food stocks statistics show 5x versus norm for rice and 2x for wheat, and we expect the government to offload these in markets should a supply shock materialise. 

NAFED may choose to do the same for pulses if the situation warrants. Indeed, the sowing situation so far is concerning, and unless rains pick up materially between now and end-August, the outlook for the kharif harvest will become bleaker, and that’s a risk demanding attention. Food inflation is set to rise for reasons beyond foodgrains, and as that happens, we expect a repeat of 2023-2024 – look through the price spike in perishables as they have a shorter turnaround time and lower tendency to generalise.

It’s a tough spot — persistence of re-escalation, El Niño intensification, rising inflation prints, oil rebound. Hence, sticking to the prudence playbook by staying put is possibly the best thing to do in the August meeting.