Banking Central | What RBI rate-setters are planning as inflation warriors face a crude threat

RBI governor will announce the monetary policy committee decision on October 9

The banking industry is all eyes on the RBI Monetary Policy Committee's review meeting this week. The general perception is that the rate-setting panel will retain the key policy rates at its meeting on October 7-9 and reserve a possible rate cut for the year-end.

Then, what changed between the last policy decision in August and the upcoming review? There have been two major developments that could probably influence the policy decision—the ongoing Iran-Israel war and the recent rate cut by the US Federal Reserve.

India is a major crude importer and the Israel-Iran crisis could trigger further escalation in crude prices that in turn may inflate India’s oil bill. That won’t be good news for inflation managers, especially the RBI, which has

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been battling to keep the inflation below 4 percent.

Economists, however, said that the central bank would keep its projects unchanged because the RBI has assumed oil prices to average at $85 a barrel in FY25 for its inflation forecast. Crude is trading at a level below this assumption now.

Then how will the MPC interpret the recent 50-bps Fed rate cut? The RBI governor has been saying that the Fed doesn’t dictate India’s rate decisions. But a higher-than-expected rate cut by the US central bank is set to influence the thoughts of the MPC members in India. Typically, smaller economies follow the US Fed rate cues. India too have done it in the past.

Inflation conundrum

Although the CPI inflation has stayed below the 4 percent mark for two consecutive months, the RBI will prefer to wait till September and October prints to get a clear pattern on price pressures, more so because the food prices still simmer in double digits.

Inflation rose to a moderate 3.65 percent in August from 3.6 percent a month back. The CPI inflation print declined to a 59-month low of 3.5 percent in July, which was below the medium-term target of 4 percent.

As per the Monetary Policy Committee’s August minutes, RBI Governor Shaktikanta Das said the headline inflation in July and Q2 of FY25 are expected to be lower, given their base effect advantage.

According to Radhika Rao of DBS Bank, for India, the US Fed’s decision is a necessary but not sufficient condition for the RBI monetary policy committee to shift expeditiously to a dovish gear. “Domestic conditions, primarily the inflation path, besides currency movements and growth impulse, should also warrant a pivot,” she said in a note.

Moderation in the July-August CPI inflation was on the back of an exceptionally favourable base effect, with stickiness in food inflation in fact offsetting a deeper pullback in the headline print, Rao pointed out.

Overall, the MPC will likely remain on hold this week highlighting that the inflation battle is not over yet.

Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.