Policy complexity: RBI MPC will have to reckon with several moving parts

With oil prices elevated and monsoon risks looming, the RBI is expected to hold rates steady while reassessing inflation and growth forecasts

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) will begin its three-day meeting today in an extremely uncertain environment. With continuously shifting positions and seemingly contradictory objectives, there is no clarity on how long tensions in West Asia will persist. Consequently, it is hard to say when the Strait of Hormuz, through which about a fifth of global crude oil flows, will open. Prices of benchmark Brent crude oil are still about 40 per cent higher than what they were before the conflict began. In terms of economic outcome, an oil-price shock tends to have stagflationary effects, which are difficult to manage. Since the pass-through of global prices has been limited and delayed, it has not yet been reflected in the retail-inflation rate, which was 3.5 per cent in April. However, higher oil prices led to a sharp increase in the wholesale price index-based (WPI-based) inflation rate, which rose to 8.3 per cent in April. The recent increase in pump prices is likely to push up both the WPI and retail-inflation rates.

 

Experts say that even if the United States (US) and Iran soon arrive at an agreement, resulting in the opening of the strait, it will take months before supplies are restored to normal levels. A potential deal between Iran and the US will obviously help reduce oil prices, though they may still remain elevated for some time. However, things could dramatically change if the war resumes — a prospect that cannot be ruled out. Thus, there are various possibilities. However, oil prices are not the only uncertainty the MPC has to deal with. The monsoon this year is expected to be below normal because of the developing super El Niño conditions, and could have an effect similar to the oil shock — higher inflation with lower growth. Central banks usually look through supply shocks, though higher rates always risk affecting expectations, potentially causing second-round effects. The complexity for Indian policymakers is that they might have to deal with two simultaneous shocks.

 

Given the prevailing uncertainties and several moving parts, it makes sense for the MPC to leave the policy rate unchanged and wait for greater clarity, while keeping the option to act if necessary. Aside from the policy decision, financial markets will also closely look at revised forecasts of inflation and growth. In this regard, it is worth noting that the National Statistics Office will publish the annual gross domestic product (GDP) numbers for 2025-26, as well as the fourth-quarter data, just hours after the monetary-policy decision is announced on Friday. To reduce the information gap, one of the two announcements could have been adjusted. Be that as it may, the RBI will likely revise its growth projection lower from 6.9 per cent for 2026-27. The latest data on goods and services tax and the index of industrial production suggests some weakness in activity.

 

The revised inflation projections will give clarity on future policy action. It is worth noting that a prolonged conflict in West Asia will keep inflation rates elevated in other countries too, and that includes the developed world. Higher bond yields in developed markets will keep global financial conditions tight, affecting capital flows. The yield on the 10-year US government bond, for instance, has increased by about 50 basis points since the beginning of the Iran conflict. The proposed mega tech initial public offerings in the US could also affect capital flows. All this could effectively keep the rupee under pressure and affect inflation outcomes. A revision in the inflation projection will also have to take this into account.