RBI May Consider Rate Hike in December Amid Stable Economic Indicators

Reserve Bank of India Unlikely to Rush into Monetary Tightening

The Reserve Bank of India (RBI) is unlikely to tighten monetary policy despite mounting inflation risks from higher fuel prices and monsoon uncertainty, according to a rating agency.

A rate hike is possible only towards the end of the year if price pressures persist. The RBI is expected to wait for clearer evidence of second-round inflationary effects before acting. Icra, a rating agency, has raised its FY27 average consumer price inflation (CPI) forecast to 5 per cent, following recent retail fuel price increases, taking inflation above the RBI's medium-term target.

The agency expects the RBI to remain on hold through the next two policy reviews, with a possible stance change in October and a rate hike only in the December policy if required. The RBI is expected to closely watch whether companies begin passing higher input costs to consumers, the so-called second-round inflation impact, rather than respond solely to the initial global commodity price shock.

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Icra's baseline projections assume crude oil prices averaging USD 95 per barrel, under which India's GDP growth is expected at 6.2 per cent in FY27, while CPI inflation is seen at 5 per cent and wholesale inflation at 6.6 per cent. Nominal GDP growth, however, could remain elevated at around 12 per cent, reflecting higher price pressures even as real growth slows.

Comparison of GDP Growth and Inflation Projections

Higher oil prices present a difficult trade-off for policymakers between inflation and fiscal management. If retail fuel prices rise further, inflationary pressures intensify and growth slows. If the government chooses to absorb the shock, fiscal pressures increase.

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Icra estimates that higher commodity prices could lead to an additional Rs 40,000 crore fertiliser subsidy burden, Rs 50,000 crore in fuel subsidies, and a Rs 15,000 crore decline in oil marketing company dividends. At the same time, excise duty collections could fall by around Rs 1.1 lakh crore, while direct tax revenues may also weaken. Although higher customs duties on gold and silver and transfers from the economic stabilisation fund could provide some offset, the agency expects a net fiscal slippage of around Rs 1.1 trillion, or roughly 0.30 per cent.

As a result, Icra now sees the Centre's fiscal deficit at 4.7 per cent of GDP in the baseline scenario, widening to 5 per cent of GDP if crude rises to USD 105 per barrel. The government would likely continue prioritising capital expenditure, even if some discretionary spending comes under pressure in the first half of the fiscal year.

Monsoon developments and the severity of an El Nino event will remain critical variables for both inflation and growth, according to Icra. While healthy reservoir levels provide some cushion for rural demand in the near term, rainfall in August will be particularly crucial for irrigation needs and Kharif output. Rural and urban sentiment had already weakened in March, suggesting caution in consumption patterns.

Icra's chief rating officer, K Ravichandran, said that the second half of the fiscal year will be more challenging for India Inc because of the El Nino factor. Tractor manufacturers, two-wheeler manufacturers, and FMCG companies will see their pricing power become very limited and margins lower in FY27. However, there is no major challenge seen from a credit quality perspective, as most of these companies are cash-rich and leveraging is very low.