As the Reserve Bank of India’s Monetary Policy Committee (MPC) convenes for its August meeting, persistent global geopolitical uncertainties continue to cloud the macroeconomic outlook. However, the RBI's recent, decisive actions to boost dollar inflows are already showing strong results.
This success has created room for the MPC to adopt a wait-and-watch approach, likely forgoing further action for now. The committee's forward guidance can remain data-dependent, without signaling a clear start to a rate-hike cycle.
The situation in West Asia remains volatile, making future energy prices difficult to predict. Our commodity strategists still anticipate a diplomatic resolution and the normalization of shipping through the Strait of Hormuz, but the timeline is now more uncertain.
In our baseline forecast, we expect oil prices to trend lower as ample global stocks should prevent outright shortages in 2026. In its June policy, the RBI based its calculations on an average crude oil price of $95 per barrel for fiscal year 2027. Despite renewed uncertainties, it is likely that the RBI's updated forecasts will reflect a lower average oil price.
Meanwhile, the US Federal Reserve held rates steady in July, though American bond yields have begun to rise. While the MPC has historically not mirrored the Fed's every move, the gap between rates on Indian and US government bonds is the narrowest it has been in years.
If this gap continues to narrow, it could become a concern for financial stability, compelling the MPC to take notice, especially if developed markets accelerate their rate hikes.
For now, however, the MPC's focus will likely remain squarely on the domestic economy. Here, the news is encouraging.
Recent high-frequency indicators suggest economic growth is more resilient than initially feared, and headline inflation has generally surprised on the downside. This should give the MPC comfort regarding the economy’s ability to absorb multiple global and domestic shocks.
Price stability
The RBI governor has repeatedly stated that price stability is the MPC's primary objective. On this front, headline Consumer Price Index inflation has recently been lower than the RBI's projections, averaging 3.9% in the first quarter of FY27 against a forecast of 4.2%. This will likely lead to a downward revision of 20-30 basis points in the RBI’s average headline inflation forecast for the full fiscal year, which was pegged at 5.1% in June.
Furthermore, the monsoon has gathered strength in July, reducing the rainfall deficit from over 40% in June to just 12%. This widespread rainfall has boosted crop sowing and, as a result, we haven't seen the unseasonal spike in food prices that many feared, even for perishable items like vegetables. While the RBI might still flag El Niño as an upside risk to inflation, the urgency to act on it has likely diminished.
The timing and extent of any future rate hike will depend on the trajectory of core inflation, especially if price increases become more generalized. The momentum in core inflation is currently in line with its long-term average.
While there has been a slight increase in recent months, it is concentrated in the restaurants and accommodation services segment. In fact, core inflation excluding precious metals remains subdued at 2.5%, showing limited signs of demand-side pressures or pass-through from higher input costs.
Looking ahead, besides an unfavorable base effect from the third quarter of FY27, two key risks to core inflation warrant close monitoring. First, increases in the Wholesale Price Index (WPI), which rose around 7.5% in the five months after the recent conflict began, typically passed through to retail goods prices with a lag.
We saw a similar dynamic at the start of the Ukraine war, though the effect faded as commodity prices eased. While many global commodity prices, particularly for petrochemical products, fell as West Asia tensions eased, they have turned up again with renewed hostilities. These raw material cost increases could eventually be passed on to consumers.
Reactive hikes
Second, robust consumption and sharp growth in retail credit could spill over into demand-driven inflation. We believe rate hikes are more likely to be reactive than proactive, becoming a real possibility only if core inflation sustains above 4.5% in a broad-based manner.
We do not expect this condition to be met soon and hence do not foresee a rate hike in 2026. In the interim, the MPC can judiciously use its tolerance band to look past temporary, supply-driven inflation spikes.
Beyond the interest rate decision, the market will be eager for guidance on liquidity management as the banking system absorbs significant foreign currency deposits with FCNR (B) inflows. If the RBI allows a one-time currency reset to correct for the rupee's undervaluation, that could also marginally reduce imported inflation pressures.
The August policy may not be about rates, but more about soft guidance on liquidity and the currency as the system adjusts to these inflows.
Samiran Chakraborty is managing director and chief economist for India at Citigroup