RBI's Calculated Move In a Turbulent World

The Reserve Bank of India (RBI) on Wednesday held the policy rate unchanged at 5.25% after its Monetary Policy Committee (MPC) concluded its deliberations. This was widely expected and the central bank held its powder dry against volatile economic and political conditions prevailing across the world. The bank also maintained a “neutral stance” on monetary policy, implying that it would be open to any future adjustments depending on prevailing economic conditions.

The MPC’s decision was unanimous.

In detailing its rationale, the MPC noted that, “Since the last policy meeting, geopolitical uncertainties have heightened significantly. Headline inflation remains contained and below the target, but upside risks to the inflation outlook have increased, driven by increased energy price pressures and probable weather disturbances affecting food prices. Core inflation pressures remain muted, although supply chain dislocations and the risk of second-round effects render the future inflation trajectory uncertain.”

While retail inflation remains within the RBI’s comfort zone, it inched up to 3.21% in February, up from 2.74% in the previous month, marking a 11-month high. Under the RBI’s flexible inflation targeting framework, the official inflation target is 4%, within a band that lies from 2% to 6%.

What made RBI take a cautious stand? At the moment, the Centre has borne the cost of rapid crude oil price increases in the wake of the US-Israel-Iran war. These costs have not been passed on to consumers of various fuels. Since February end, when the conflict began in West Asia, India has purchased large volumes of crude oil from Russia even as ships bearing supplies for India remained marooned in the Strait of Hormuz.

The result is that the actual price shock from scarcity of not just fuel but multiple by-products and other goods requiring raw materials based on crude oil is yet to be felt. There are indications of supply chain risks. The Finance Ministry’s Monthly Economic Report for March noted that, “While fertiliser availability remains manageable in the near term, risks persist for the rabi season if the situation remains unresolved. Input cost increases and logistical constraints may affect farm operations, even as some export-oriented crops experience price declines due to demand disruptions.” The report cautioned against potential disruptions in the time ahead.

If these disruptions were to materialise in the months ahead, a reduction in the policy rate on Wednesday would have added to inflationary pressures that have been building up. The caution on RBI’s part is well-warranted.

On the other side of the inflation-growth trade-off, questions have been raised if RBI should have supported growth at this juncture. Ratings agencies such as Moody’s have cut India’s growth forecast for 2026-27 to 6% from the 6.8% estimated earlier. Similarly, Morgan Stanley has reduced its forecast for India’s GDP growth in 2026-27 to 6.2% from the previous 6.5%.

Properly speaking, there really is not a growth-inflation trade-off at the moment. At the moment, the Indian economy is chugging along at 6.8% (first quarter estimate for 2026-27). RBI’s forecast for 2026-27 currently stands at 6.9%. This is a fairly robust rate of growth given India’s economic fundamentals. Reducing the policy rate when there are on-going global supply shocks and inflation is inching up, does not make sense. If growth needs support at some point, it is better to support it via fiscal means rather than reducing interest rates. That situation is yet to arise.

The MPC stated that, “Growth impulses continue to be supported by robust private consumption and investment demand...However, the fundamentals of the Indian economy are on a stronger footing, providing it with greater resilience to withstand shocks now than in the past. The economy is confronted with a supply shock. It is prudent to wait and watch the changing circumstances and the evolving growth-inflation outlook.”