On Friday, the central bank kept benchmark repo rate unchanged at 5.25%, but raised FY27 inflation projections to 5.1% -- 50 bps higher than 4.6% projected in April. As higher energy prices pass-through the economy via higher transportation costs, food prices and so on, the impact is likely to be felt on the broader economy and so RBI revised FY27 growth estimates downwards to 6.6% from 6.9% projected earlier. Disappointingly, its 100 bps lower than FY26's real GDP growth of 7.6%.
In April, headline inflation increased for the sixth straight month to settle at 3.48% with food inflation printing at 4.2%. But as Governor Sanjay Malhotra noted, retail inflation remained well below the RBI's 4% target in both March and April. However, April's wholesale price inflation hit 8.3% -- the highest in nearly four years. It means, consumers may soon witness the reality in their shopping baskets as the pass-through of higher input costs to headline inflation is becoming evident. What's unclear though is if the price rise is transitory or remains sticky yet again.
Acknowledging that uncertainty prevails with regards to both the duration and magnitude of the West Asia conflict, the Monetary Policy Committee (MPC) retained the policy stance at nuetral. Accordingly, inflation in Q1 is pegged at 4.2%, Q2 at 5.1%. Q3 at 5.9%, and Q4 at 5.4%, while core inflation for FY27 is estimated at 4.7%.
The upward revision in inflation forecasts implies that rate cut chances have slipped from slim to zero, while rate hikes are firmly perched on the bench. Though Malhotra gave no such hint, he did indicate the central bank's readiness to act if inflation expectations become unanchored. As it is, markets have already jumped from 50 bps worth rate cuts just two months ago to 50 bps worth rate hikes in FY27.
If in April Malhotra warned of a supply-side shock from higher crude oil prices eventually causing broader demand-side inflationary pressures, on Friday, he noted that global environment further deteriorated since the MPC's last meeting and that adverse disruptions are getting reflected in global growth moderation and higher inflation projections.
Global oil prices are expected to average $95 per barrel (or above) this year as oil inventories are likely to approach critical levels in the coming weeks. Which means, India's oil price basket may average higher than RBI's April estimate of $85 per barrel in FY27. Private estimates project that higher oil prices will likely add 1.3% to annual inflation, much higher than RBI's read of 50 bps, while weather-related disruptions could contribute another 0.3%-0.5%.
Citing inflation, weakening rupee, and sustained foreign capital outflows, some insist RBI to raise rates as if it's the golden key that opens all doors. Rupee has been under pressure and touched a historic low of near 97 per dollar last month due to sustained capital outflows, and rising import bill. In fact, other Asian economies have raised rates to defend the currency depreciation and as Malhotra himself noted, advanced economies are likely to pivot towards tightening this year. In fact, Indonesia and Sri Lanka have raised rates by larger-than-expected 50 bps and 100 bps respectively, to arrest currency depreciation and prevent capital outflows. Importantly, Japan is expected to raise rates mid-June.
But others maintain that rate hikes right now will be detrimental to growth. Higher rates dampen borrowing and investment, and won't help in arresting inflation or rising oil prices. So instead of raising rates and slowing down economic activity, Malhotra preferred to wait and watch for the second-round effects of inflation to unfold, before taking a call. As for the emerging risks to inflation, the government has stepped in with excise duty cuts and higher fuel prices to retail consumers last month.
More than policy action, Friday's policy has much to do with Foreign Institutional Investors (FIIs), who offloaded equities worth $22.7 billion in just the last two months. This, along with higher import costs including oil, gold and electronics, rupee weakened nearly 6% this year and remains as one of Asia's worst performing currency.
On Friday, RBI announced measures to boost foreign inflows and support forex stability by expanding access to all new issuances of 15-, 30- and 40-year tenor G-secs. Until now, FIIs were allowed to invest only in 10-year G-Secs.
In addition, limits pertaining to short-term investment, concentration and individual securities on FPI investment under the general route are being removed. These measures along with the tax benefits
announced on Friday should help attract foreign capital for government borrowing. The RBI also increased the limits for investment by NRIs and OCIs in equities.