Reserve Bank of India (RBI) Governor Sanjay Malhotra has done well to refrain from immediate rate action, despite bond markets having anticipated one. His message—dovish yet circumspect—appears prudent. While he flags the possibility of a demand shock, the central bank’s forecasts stop short of sounding alarmist.
Navigating the Oil Shock
A rate hike at this juncture would have offered little relief. The economy is already grappling with a sharp oil shock, and the disruptive effects of the West Asia conflict are unlikely to dissipate anytime soon. Even absent the recent ceasefire, holding policy steady would have been the wiser course, rather than risking a reversal later. With multiple uncertainties in play, maintaining a neutral stance preserves policy space—dry powder for when it is truly needed. In any case, with oil prices easing to around $93-94 a barrel and curbs on banks’ net forex positions in place, the rupee has recovered some lost ground. Lower oil prices, softer global yields, and the policy stance have also helped calm bond markets, with the benchmark yield closing below 7%.
That said, the RBI’s assessment of both growth and inflation trajectories for the year appears somewhat optimistic. Price pressures are building—not just from imported inflation via higher oil and gas prices, but also as companies pass on rising input costs to consumers. This trend is likely to persist, and any increase in pump prices would add further to inflationary pressures. The comfort around the 4.6% CPI projection for FY27 seems to stem from relatively benign core inflation. While, as the governor noted, the last two readings came in below 4%, the current environment—shaped by a supply shock—is materially different. If crude averages $85 a barrel, as assumed, inflation may still remain below 5.5%, which would be manageable under present conditions.
Optimism Gap
Inflationary pressures could, of course, be tempered if growth slows. Even so, the GDP growth projection of 6.5% for FY27 appears somewhat optimistic, particularly the revised Q1 and Q2 estimates of 6.8% and 6.7%. With oil prices likely to remain elevated at $85-90 per barrel for an extended period, a persistent gas shortage weighing on domestic production, and merchandise exports facing headwinds in a tariff-unfriendly and slowing global economy, a more tempered outlook might have been expected.
To be sure, the governor acknowledged that an initial supply shock could morph into a demand shock if supply chain disruptions persist. It is possible the RBI prefers to wait for greater clarity rather than signal undue pessimism—note that the upward revision to inflation is more pronounced than any change in the growth outlook. While stronger nominal GDP growth may support corporate profits, a meaningful pickup in aggregate demand appears unlikely unless normalcy returns soon. Even prior to the recent geopolitical tensions, private consumption had remained uneven despite supportive fiscal and monetary measures.
Earnings estimates for FY27 have already been pared back, raising questions about the return of foreign portfolio inflows into equities. While Indian markets may appear less expensive than at the onset of the conflict, several global markets now offer more attractive valuations. Governor Malhotra expressed confidence on foreign direct investment, but while repatriation pressures may ease, fresh inflows are far from assured. The RBI has clarified that recent measures to curb speculation are temporary, but markets would do well to note that the central bank will not hesitate to deploy them again if needed.
For now, much rests on whether the ceasefire holds.