RBI's balanced pause raises bar for future rate hikes: Amar Ambani, YES Sec

Disclaimer: This article is written by Amar Ambani, executive director, YES Securities. Views expressed are his own. Readers' discretion is advised.

 

The Reserve Bank of India (RBI), through its Monetary Policy Committee (MPC), unanimously decided to keep the policy repo rate unchanged at 5.25 per cent, while retaining the neutral policy stance. The decision was widely in line with the market consensus as the central bank continues to navigate an increasingly challenging macroeconomic environment marked by elevated crude oil prices, geopolitical tensions in West Asia and weather-related uncertainties. 

Although headline inflation has risen following the recent energy price shock, it remains within the RBI's tolerance band, allowing policymakers to adopt a wait-and-watch approach rather than pre-emptively tightening monetary policy. The RBI reiterated that future policy decisions will remain strictly data-dependent, balancing inflation risks against the need to sustain economic growth.

 

 

Inflation Turns Marginally Constructive, But Risks Elevated

The RBI's inflation outlook has turned marginally more constructive despite upside risks. While elevated crude oil prices, El Niño-related weather risks and persistent supply-side disruptions are expected to keep headline inflation elevated over the coming quarters, the RBI emphasised that the recent rise in inflation remains largely concentrated in food and fuel and has yet to become broad-based. Reflecting a relatively improved near-term outlook, the RBI lowered its FY27 CPI inflation forecast to 5 per cent from 5.1 per cent projected earlier. Nevertheless, the RBI cautioned that risks remain tilted to the upside. 

 

Although core inflation continues to remain well contained, particularly core inflation excluding precious metals, sustained increases in food and fuel prices could gradually spill over into wages and broader consumer prices, creating second-round inflationary effects. Consequently, the central bank emphasised the need to remain vigilant even as underlying demand-driven inflation remains moderate.

 

Growth Outlook Improves, But External Risks Persist

Despite the increasingly uncertain global backdrop, the RBI struck a relatively optimistic tone on domestic growth. Strong domestic demand, resilient investment activity, healthy bank credit growth and robust services sector momentum continue to support the economy. Reflecting this resilience, the RBI revised its FY27 real GDP growth forecast upward to 6.7 per cent from 6.6 per cent estimated earlier, while cautioning that geopolitical tensions, elevated commodity prices and weather-related disruptions continue to pose downside risks to the outlook. The central bank believes India's macroeconomic fundamentals remain strong enough to absorb external shocks, although sustained escalation in global conflicts could weigh on both growth and inflation going forward.

 

The Bar for Further Rate Hikes Rises

The August policy suggests that the urgency for further policy tightening has moderated to some extent. While the RBI continues to flag significant upside inflation risks, the downward revision in its inflation forecast and upward revision in its growth forecast indicate a more balanced assessment of the macroeconomic outlook. We therefore believe the bar for additional rate hikes has risen materially. Any further policy tightening is likely to remain contingent on a sustained rise in energy prices or evidence of broader, demand-driven inflationary pressures, rather than the current supply-led increase in headline inflation. 

 

That said, we continue to expect the RBI to deliver at least two rate hikes, amounting to a cumulative 50 basis points, over the next 12 months. Such a move would take the repo rate to approximately 5.75 per cent, enabling the RBI to maintain a positive real policy rate of at least 75 basis points. This would be consistent with the central bank's objective of keeping inflation expectations firmly anchored while preserving macroeconomic stability.