Neutral pause suggests rate hikes aren't imminent: Aditi Nayar

We broadly concur with the MPC's growth forecasts for FY2027, notwithstanding some differences in the quarterly projections, Nayar said.

Disclaimer: The author Aditi Nayar is the Chief Economist and Head- Research & Outreach at ICRA. Views are her own.

 

The Monetary Policy Committee (MPC) expectedly maintained status quo on the policy rates and the stance in its August 2026 meeting. Limited evidence on the generalisation of inflationary pressures, benign core inflation excluding precious metals, and the recovery in Southwest Monsoon rainfall in July 2026 following the large deficit in June 2026, supported the Committee’s decision to hold rates steady at the current juncture. These factors also supported a switch to a relatively neutral tone in the policy document, from a hawkish one in June 2026. 

 

 

The Committee raised its real GDP growth projections for FY27 marginally to 6.7 per cent from 6.6 per cent in the June 2026 policy, amidst a 40 basis point (bps) upward revision in the Q1 forecast to 7 per cent owing to the stronger-than-expected turnout of high frequency indicators for the quarter. 

 

While it raised the growth forecast for Q2 by 10 bps to 6.4 per cent, that for Q3 and Q4 was kept unchanged at 6.5 per cent and 6.8 per cent, respectively. It highlighted that deficient and uneven rainfall poses risks to the agri outlook and rural demand. Nevertheless, the commentary around urban demand, investment activity and exports was fairly positive. In the MPC’s assessment, risks to growth are evenly balanced, which marks a shift from their prior judgment of downside risks in the June 2026 meeting. 

 

We broadly concur with the MPC’s growth forecasts for FY2027, notwithstanding some differences in the quarterly projections. For instance, we agree that the growth in volumes across several high frequency indicators has been quite robust in Q1-FY27. Despite this, the GDP growth turnout could be somewhat lower than the MPC’s estimate for that quarter, amid a compression in margins owing to the surge in input costs, which is expected to weigh on the value-added growth across sectors. We are somewhat more optimistic around growth outcomes in H2 FY2027, unless geopolitical uncertainties worsen.

 

Nevertheless, we believe that risks to growth are tilted to the downside. In our view, investment activity remains supported by selected new-age sectors, and any adverse geopolitical developments could weigh on sentiments and private sector activity in the near term. While at present the risk of fiscal slippage appears mild, a prolonging of West Asia tensions and elevated commodity prices may end up constraining Government capex, which has played an important role in supporting infrastructure activity.  

 

On the inflation front, the CPI inflation projection for FY2027 has been pared slightly to 5.0 per cent from 5.1 per cent in the June 2026 meeting, amid a lower-than-forecasted reading for Q1, and a 40 bps downward revision in Q2 print to 4.7 per cent. While the forecast for Q3 was kept unchanged at 5.9 per cent, that for Q4 was raised marginally to 5.5 per cent, and a fresh projection was issued for Q1 FY2028 at 5.3 per cent. 

 

As against the 10 bps cut in the headline CPI inflation projection for FY2027, the core inflation forecast was pared by a sharper 40 bps to 4.3 per cent from 4.7 per cent in the June meeting. This suggests that the non-core portion, which includes food and fuel, has seen an upward revision since the last meeting, amidst the uneven monsoon.  Besides, the MPC stressed that core inflation, excluding precious metals, is expected to be lower in the near term, suggesting that demand pressures remain contained, before aligning with core inflation by the end of the fiscal. 

 

The MPC’s inflation forecasts are in line with our own assessment. Here too, the Committee has transitioned to risks being evenly balanced as against its prior assessment of upside risks. Overall, we believe that the Committee’s growth and inflation forecasts are appropriate for an average crude oil price of $80-85/barrel and a moderate rainfall deficit. 

 

The tone of the MPC document does not suggest that monetary tightening is imminent, indicating a continuation of the extended pause. Nevertheless, we continue to believe that the next move on rates is going to be a hike. The MPC’s own projections place the headline CPI inflation above the 5 per cent mark in Q3 FY2027, Q4 FY2027 and Q1 FY2028, well above the mid-point of the target range of 2-6 per cent, suggesting that the real policy rate will remain compressed. 

 

The policy document also stresses on ‘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’. We interpret this as the need to recalibrate policy rates, particularly in real terms, with the CPI inflation moving up sharply to 5.0 per cent in FY2027 from the unusually low 2.1 per cent seen in FY2026. 

 

The timing of this turnaround in the rate cycle remains contingent on the trajectory of crude oil prices, which have been particularly volatile since the onset of the tensions in West Asia, their transmission to retail selling prices of fuels, as well as the rainfall outcomes in the remainder of the monsoon season. At the current juncture, we believe that a tighter monetary policy could begin unfolding in the December 2026 meeting, particularly if there is evidence of a generalisation in inflationary pressures.