RBI's rate-setting panel hints at future policy tightening if inflation persists

Mumbai: The Reserve Bank of India (RBI) held its policy rate steady even as retail inflation has risen steadily in recent months, with governor Sanjay Malhotra signalling that the central bank has left open the direction of its next rate move, depending on how persistent the price pressures prove to be, the minutes of the August policy meeting, released on Wednesday, showed.

Retail inflation rose from 2.74% in January to 4.45% in July, with food and fuel prices driving much of the recent increase. Yet the RBI’s monetary policy committee (MPC) kept the repo rate unchanged at 5.25% at its 5 August meeting, choosing to wait for greater clarity on whether the rise in inflation will persist or become broad-based.

“I would prefer to wait for more certainty to emerge on the inflation trajectory in terms of the persistence of realised prints at these or higher levels, the forecast, and the likely levels to which inflation may normalise and settle for any recalibration of the policy rate,” he said.

He also cautioned that the central bank would need to remain vigilant to risks from food, fuel and other input prices feeding into broader inflation. “Any evidence of these risks materialising may need policy tightening,” the governor said in his statement recorded in the minutes of the MPC meeting.

Malhotra himself had voted to keep the repo rate unchanged at 5.25% and to retain the ‘neutral’ stance on 5 August.

Headline inflation has averaged 3.93% from January to July this year, while core inflation, which excludes volatile food ⁠and fuel ​components and better reflects underlying demand, stood at 3.9% in July, against ​an expectation of 4.08%.

Core inflation is expected to converge with headline inflation in the final quarter of this fiscal year, which may suggest a recalibration of the policy rate. The central bank has projected core inflation to average 4.3% in FY27.

Inflationary pressures

According to Malhotra, the current rise in headline inflation was primarily supply-driven, with higher food and fuel prices accounting for much of the increase. He said there were limited signs of generalisation of inflation, while core inflation remained modest and inflation expectations were contained.

He said inflation was expected to peak in the third quarter before moderating, while the economy remained resilient despite external headwinds. He retained the RBI’s FY27 growth projection of 6.7%, calling the pace ‘robust, given the headwinds.’

Despite the conflict in West Asia disrupting supply chains, heightened uncertainty, and an erratic monsoon so far, the Indian economy has performed better than expected in the June quarter, he said, adding that it is expected to remain resilient going ahead.

The RBI’s retail inflation projection for FY27 has been revised downwards by 10 basis points to 5% compared to 5.1% made in the June policy, and its GDP growth projection has been raised by 10 basis points (bps) to 6.7% from 6.6% earlier. A hundred bps equals one percentage point.

Other MPC members also echoed Malhotra’s view on recalibrating monetary policy if inflation pressures persist, while maintaining a pause at the current juncture.

“The persistence of high fuel prices is likely to feed into second round inflation, resulting from pass-throughs of higher input costs to consumer prices,” Saugata Bhattacharya said in the recorded minutes, while adding that inflation risks “might then become tilted to the upside”.

Bhattacharya said the MPC should wait for evidence of a further pickup in aggregate demand and a generalisation of price pressures before its next policy action. However, he said the normalisation of underlying inflation would require the central bank to determine the appropriate time to recalibrate the policy rate.

“There is a clear hawkish ladder among the MPC members,” SBI Research said in a report on Wednesday. The governor's MPC minutes statement shows inclination towards policy tightening, while deputy governors and the central bank call for a possible rate hike later in the year. “External members Ram Singh and most importantly Saugata Bhattacharya also talk about policy recalibration /swift adjustments,” the SBI report said.

In a report on Wednesday, Barclays said it expects no rate change this year, and a 50 bps hike in 2027. “We think the risk of an earlier hike would only materialise if inflation shows signs of sustained second-round effects, such as cascading fuel costs into broader transportation fare hikes and/or slower-than-expected monsoon rainfall that translates into a food supply and consequent price shock,” the report said.

Poonam Gupta was more explicit about the possibility of a rate hike. “The scope for any further easing does not seem to exist at the current juncture. Instead, given that the headline inflation is projected to peak to a level as high as 5.9% in Q3 2026-27, a case for a hike may emerge during the course of the year,” she said.

However, Gupta also favoured waiting for greater clarity on weather-related risks, the extent to which supply-side inflation becomes entrenched and the global outlook. She said retaining a neutral stance would signal that the future course of policy action should be data dependent.

Another MPC member, Indranil Bhattacharyya, also flagged the risk of inflation becoming more widespread. “One must look out for the extent of generalisation and risk of inflation expectations getting unanchored before contemplating any rate hike.”

He stressed that the reaction function would determine the timing and calibration of policy. “On this count, a pause preserves flexibility on timing; it does not necessarily imply an extended pause.”

Ram Singh called for maximum operational flexibility. “If external shocks worsen or the second-round price effects spread widely, we should be able to swiftly adjust policy to protect macroeconomic stability,” Singh said, adding that incoming data would be crucial in assessing the extent of such effects.

Nagesh Kumar struck a more cautious tone, saying that at the current juncture, there does not seem to be a case for a monetary policy action and voted for the status quo.