Oil prices and monsoon uncertainty will shape RBI's inflation outlook

June inflation rose above the RBI's 4% target, with food, oil prices and monsoon risks clouding the outlook, making a status quo on rates the likely policy choice

The consumer price index-based inflation rate for June crossed the Reserve Bank of India’s (RBI’s) target of 4 per cent for the first time since January 2025. The data, released on Monday, showed that the inflation rate in June increased to 4.38 per cent, compared to 3.93 per cent in the previous month. The increase was driven largely by higher food and fuel prices. The food-price inflation rate increased to 5.32 per cent. The core inflation rate is estimated to be around 4 per cent. The Monetary Policy Committee (MPC), which will review policy in early August, will have the June inflation data as the latest available. While the headline number is not alarming in itself, the complexity of the current macroeconomic environment is likely to dominate the committee’s deliberations.

 

Global prices of crude oil dropped sharply after the United States (US) and Iran agreed to a ceasefire and to resolve outstanding issues through negotiations. The price of the Indian crude basket came down from an average of about $114 per barrel in April to about $71 in July. However, as many had expected, the fragile ceasefire could not hold, and both sides have been exchanging fire over the past few days. As a result, shipping traffic through the Strait of Hormuz, which facilitates the movement of about 20 per cent of global crude oil, has declined significantly. US President Donald Trump has claimed that the Strait is open and that America will ensure it remains open for all countries except Iran, but at a fee. The US asking for reimbursement for providing security is problematic in itself and has wider geopolitical implications. Besides, the conflict clearly showed that stopping Iranian attacks would not be easy. Iran managed to hit various targets in the region at will.

 

Thus, the level of supply through the strait will remain uncertain as long as both sides don’t arrive at a mutually acceptable agreement. This will keep oil prices elevated in the near term. India only partially passed on the increase in prices of crude oil to retail pump prices. With prices firming up again, the possibility of retail prices coming down in the near term can easily be ruled out. Thus, it would continue to impart upward pressure on the inflation rate and that will need to be factored in while making forecasts.

 

The other big area of uncertainty is food prices. The monsoon has had a weak start, and the rainfall deficit stands at about 18 per cent. This has resulted in about a 16 per cent, year-on-year, decline in kharif sowing. Although India has a comfortable stock of food grains, a substantial drop in kharif output will push up food-inflation rates, in part through the increase in prices of perishables. The impact can potentially extend to rabi crops. Therefore, a weaker than expected monsoon can create significant policy complications. Central banks usually look through seasonal spikes in food prices.  However, higher prices owing to a weak monsoon could be more persistent. The June meeting of the MPC had projected an average inflation rate of 5.1 per cent for this financial year. The higher level of uncertainty in the economic environment makes forecasting enormously more difficult. The RBI may retain the inflation projection for now and wait for more clarity. In terms of policy action, it will make sense to maintain the status quo for now. A case for a rate increase will start building only if inflation projections increase significantly beyond the current estimates, which looks unlikely at this stage. A lot will depend on how the situation in West Asia unfolds and how the monsoon progresses.