RBI signals shift in balance of threats

The Reserve Bank of India’s Monetary Policy Committee (MPC) unanimously voted to keep policy rates unchanged in its April review, maintaining a neutral stance while striking a cautious tone. The central bank flagged risks emanating from West Asia, warning that a prolonged conflict could push supply-side pressures into demand-side inflation.

The MPC’s macro outlook reflected a stagflationary tilt, with downside risks to FY27 growth and upside risks to inflation, marking a notably unbalanced outlook after a prolonged period of stability.

The RBI also highlighted potential spillovers from global financial markets. A prolonged conflict could tighten domestic financial conditions and raise borrowing costs. During the post-policy press conference, RBI Governor Sanjay Malhotra welcomed the recent US–Iran ceasefire as a positive development, though uncertainty around supply normalization remains elevated.

Growth for the first half of FY27 has been revised downward by 20 basis points from the February policy, reflecting the updated GDP series. The forecast assumes that the conflict’s impact will remain contained in the near term. However, escalation risks, broader spillovers, potential damage to energy infrastructure, and weather-related shocks continue to pose downside risks to growth.

On inflation, apart from elevated energy prices linked to the West Asia conflict, the MPC flagged potential El Niño risks as an upside threat. For the first time, the RBI projected core CPI at 4.4% for FY27, noting that underlying inflation momentum appears even weaker when excluding precious metals. At the same time, it cautioned about possible supply chain disruptions and second-round effects.

The Monetary Policy Report’s sensitivity analysis suggests that if crude oil averages USD 95 per barrel in FY27, growth could slow to 6.7%, while headline CPI may rise to 5%.

While there is optimism that the ceasefire signals a move toward de-escalation, analysts note that in periods of stress, policy responses must extend beyond inflation management to focus more on macro-financial stability and proactive foreign exchange management.

With these considerations, Emkay Global Financial Services believes the bar for a conventional rate hike remains high, contrary to market expectations of up to three hikes in FY27. A sustained supply shock would be required to push headline inflation persistently above target, particularly if energy prices begin feeding into core inflation and inflation expectations.

For now, analysts expect the conflict to peak in Q1, with inflation broadly aligning with the RBI’s projection of 4.6%, assuming Brent crude averages around USD 80 per barrel. However, sustained and significant unsterilized foreign exchange intervention could drain domestic liquidity and push up money market rates. Additionally, expanding the RBI’s already sizeable net short forward position could impose costs over time, potentially tightening system liquidity and exerting pressure on the rupee as contract maturities approach.