RBI Policy Preview: A Cautionary Wait Ahead

RBI Faces Inflationary Pressures Ahead of June Policy Meeting

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) is likely to face increased policy challenges ahead of its June meeting, following the West Asia conflict. During the April meeting, MPC members discussed the growth-inflation mix, highlighting concerns over growth but expressing optimism about projections due to adequate food buffers, healthier balance sheets, and continued public capex.

However, since the last policy meeting, developments have shifted towards the inflationary front. In April, MPC members expressed caution regarding inflation but took comfort from the fact that core inflation was steady. The recent surge in input costs, such as freight and shipping costs, has been a major concern. The RBI has calculated that a 5 percent depreciation of the currency increases the Headline CPI by around 35 bps.

The government's decision to pass on some portion of the under-recoveries of oil marketing companies (OMCs) to consumers has also contributed to higher inflation. Petrol prices have increased by 7.4 percent in four different rounds, while diesel prices have gone up by 8.4 percent and CNG prices have moved up by 4.4 percent. These increases will have a second-round impact on Headline inflation, particularly affecting logistics and transportation costs.

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The impact of imported inflation is first felt on the Wholesale Price Index (WPI). In April, WPI surprised with a jump to 8.3 percent from 3.9 percent in the previous month, led by crude prices and core WPI inflation. Within the core inflation, prices of basic metals, textiles, and chemicals show a significant jump. Our analysis shows that manufacturing input costs and farm input costs have seen a sharp rise in April.

The RBI's surveys indicate that manufacturers report higher input prices and are ready to pass on the same to consumers. From a theoretical perspective, monetary policy has a limited scope to address supply-led price shocks. However, the RBI may need to consider the second-round implications of the supply shock on prices.

Our inflation model points to a 4.9-5.0 percent inflation for FY27, with a peak at 5.6 percent in Q3 and 5.2 percent in Q4. The extension of the cease-fire for 60 days is a positive for oil price pressures being restrained. Given the uncertainties, the RBI will have to take all parameters into consideration, including the sacrifice on growth that would result from a hike in policy interest rates.

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The extent of rate hikes that are likely, whenever the RBI decides to hike rates, remains uncertain. By the most simplistic logic, if the average inflation for FY27 is at ~5.0 percent and we build a real gap of 1 percent over it, then the policy rate can potentially move up to 6.0 percent, or 75 bps higher than the current level of 5.25 percent.

However, the decision to start hiking or the extent of the hike remains uncertain, given that the understanding of whether inflation pressures will be transitory or permanent is missing. The RBI may have to implement a 50-bps dose if the MPC feels it is falling behind the curve. For now, given our assessment, we think that the RBI would skip June as the starting point of its rate hiking cycle.