Opinion RBI sees inflation risks — but growth comes first
With global inflationary risks rising, in the coming months we could see a rate hike by the US Federal Reserve and further rate hikes by the ECB and the BoJ. This in turn could put some weakening pressure on the Indian currency
India’s external sector has been managing well in the midst of the volatile global environment. The RBI Monetary Policy Committee left the policy rate unchanged and retained its neutral stance in the August meeting. While this is along expected lines, the tone of the policy was more dovish than expected. With the risk of food inflation rising and volatile crude oil prices, we expected the central bank’s tone to be more cautious.
The RBI highlighted that while CPI inflation is rising, it is mainly because of higher food and fuel prices. CPI inflation has increased steadily to 4.4 per cent in June from 2.7 per cent at the beginning of the year. However, even with high input-cost inflation, core inflation (excluding food and fuel) has remained relatively lower. In fact, core inflation excluding precious metals, which reflects demand-side inflation, is at a benign 2.4 per cent. The central bank has marginally lowered the average CPI projection for FY27 to 5 per cent, while highlighting that so far supply-side inflationary pressure has not become broad-based. However, volatile global crude oil prices and weak monsoon remain as inflationary risks.
On the growth front, the central bank was quite optimistic and raised the GDP growth projection marginally to 6.7 per cent for FY27, in line with our projection. Even in the midst of the uncertain macro-environment marked by the West Asia crisis, US tariff threats, and the likelihood of a deficit monsoon, the Indian economy is showing strong resilience.
High-frequency macro indicators like IIP, ISP (Index of Services Production), core sector, bank credit demand, and exports growth have been quite robust. The corporate performance in the first quarter is also looking healthy. Based on the healthy data so far, growth in the first quarter is likely to be strong at around 7 per cent. However, there will be some moderation in the subsequent quarters as the economy feels the adverse impact of the West Asia crisis. Progress of the monsoon and subsequent impact on the agriculture sector and rural demand is the other important factor to watch.
India’s external sector has been managing well in the midst of the volatile global environment. After a weak FY26, India’s goods exports have picked up by a strong 16 per cent in Q1 FY27. And it’s not just because of high crude oil prices as exports excluding petroleum products have also recorded a strong growth of 13 per cent in this period. Services exports and remittances have also remained healthy.
While the current account deficit is expected to widen in FY27, we expect it to remain comfortable at around 1 per cent of GDP. Financing of even a small current account deficit had become a challenge in the last two years because of feeble capital flows. However, the recent measures announced by the central bank are likely to aid the same. We are already seeing strong inflows coming in through FCNR deposits. FII inflows into debt and equity have also improved as per recent data.
Overall, the Balance of Payments is likely to move to a large surplus in FY27 from deficits recorded in the previous two years. This should be supportive of the Indian rupee. But we will have to closely watch the policy action of the major central banks globally. With global inflationary risks rising, in the coming months we could see a rate hike by the US Federal Reserve and further rate hikes by the ECB and the BoJ. This, in turn, could put some weakening pressure on the Indian currency.
Given the uncertain macro-backdrop, the future policy decisions of India’s central bank will remain data-dependent. The RBI is likely to keep the policy rate on hold, unless the inflationary risks aggravate. With food inflation likely to peak in Q3 FY27, the real rate of interest could turn negative temporarily. However, the central bank may look through it if the inflationary pressure is supply-side and there are no indications of the pricing pressure getting broad-based. In this fluid global and domestic environment, the central bank may prefer to remain growth-supportive.
The writer is chief economist, CareEdge Ratings
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