West Asia conflict threatens Indian economy's 'Goldilocks' phase

RBI's MPC may face a tough growth-inflation trapeze

A prolonged war in West Asia can come in the way of the optimism of the Reserve Bank of India (RBI), which last month had said the economy was in a “sweet spot”.

 

The central bank is increasingly seen to walk the macroeconomic tightrope, balancing looming inflationary pressures against intensifying growth headwinds triggered by a surge in crude-oil prices, which topped $100 a barrel on Monday.

 

Market participants remain divided on whether “the lower (interest rate) for longer” narrative would hold.

 

Since December 2024, the Monetary Policy Committee (MPC) has reduced the policy rate by 125 basis points to 5.25 per cent. The MPC had indicated the interest rate might not rise in the near future.

 

“The (RBI) governor said in a recent interview that the rates were likely to be around this level or lower for a long time. He did, however, qualify that by saying this was barring any shocks,” said Suyash Choudhary, chief investment officer, fixed income, Bandhan AMC.

 

“… The ongoing geopolitical developments can easily be classified as a major shock. Both the starting point for this, as well as the potential intensity, can alter monetary policy expectations going forward,” Choudhary said in a note.

 

The central bank’s main concern is global oil prices and whether supply chains will stay intact.  

 

Madan Sabnavis, chief economist, Bank of Baroda, said a rate increase sooner than expected could not be ruled out if prices rose at a fast clip.

 

“As of now, it (rate increase) does not appear to be on the cards, but depending on how things evolve, the RBI will decide,” Sabnavis said. “The crux is the length of the war and the oil economy. It is not just prices but quantity that matters.”

 

In its February monetary policy review, the Monetary Policy Committee kept the policy repo rate unchanged at 5.25 per cent and retained its “neutral” policy stance, signalling a wait-and-watch approach.

 

Some experts said a cautious, data-dependent approach was likely to dominate the domestic rate-setting panel’s near-term strategy.

 

Aditi Nayar, chief economist, Icra, said how long the conflict would continue and its repercussions on oil prices and domestic inflation remained largely unknown.

 

“It may be prudent to wait and watch and reassess the evolving situation in each policy meeting,” Nayar said.

 

An early end to the conflict can heavily bring down oil prices, which would once again make “lower for longer” the baseline scenario, she said.

 

Some economists are of the view that maintaining the pause in policy rates is justified, given the immediate risks to growth and the presence of structural domestic buffers, which could help contain prices.

 

Gaura Sen Gupta, economist, IDFC First Bank, expects the central bank to look through the initial supply shocks.

 

“Increasing policy rates would only add to the downside risks to growth,” Gupta said, adding that the RBI was expected to keep the rates unchanged and ensure ample domestic liquidity.

 

She said that the headline inflation rate would stay in control in the immediate term if the prices of retail petrol and diesel were not increased.

 

“Inflation for now is not expected to be significantly impacted,” Sen Gupta said.

 

“The first shock absorbers of a rise in crude-oil prices will be oil-marketing companies (OMCs) and the central government.”

 

The central bank will reassess its growth and inflation projection in the next policy review in April.

 

In the February policy, the retail inflation for the first and second quarters (Q1 and Q2) of next financial year are projected at 3.9 per cent and 4.0 per cent, respectively, while real growth in gross domestic product for Q1 and Q2 of FY27 was projected at 6.7 per cent and Q2 at 6.8 per cent, respectively.