Middle East tension unlikely to impact RBI projections on inflation, say experts

Post the Fed rate cut, certain emerging market central banks have reduced their respective policy rates, and there is hope in certain pockets that the Reserve Bank of India too may follow the Fed. We, however, do not anticipate a change in the policy rate or in stance

The escalating tension in the Middle East between Iran and Israel is unlikely to have a major impact on the Consumer Price Index (CPI) inflation, according to experts. The resultant rally in crude oil prices hasn’t been very steep so far with the Brent crude shooting up by less than $5 a barrel between October 1 and 4.

Historically, it is only when crude prices rise by $10 a barrel or more that it widens India's current account deficit by 0.55 percent. The CPI inflation increases by 0.3 percent or 30 bps in effect. To put things in context, oil price has a deep implication on India’s inflation, given that it constitutes major portion of the nation’s import bill.

According to Bloomberg data, Brent crude prices inched up to $78.32 a barrel at 2:02pm on October 4 from $73.56 on October 1 and $71.77 on September 30.

The rally was triggered after Iran fired around 181 ballistic missiles at Israel in retaliation to the war in Gaza against the Hamas of Palestine, Houthis of Yemen and the Hezbollah of Lebanon. Israeli Prime Minister Benjamin Netanyahu warned that Iran would have to “pay for its attack” of October 1.

“The impact on inflation will result from higher oil prices. So far, the impact on oil prices has been muted. Unless the oil prices stay above $100 a barrel on a sustained basis, then there could be a cause for concern for India,” said Aditi Gupta, economist at Bank of Baroda. However, Gupta says the possibility of this scenario is slim as of now.

Kanika Pasricha, chief economic advisor at the Union Bank of India, ruled out any possible threat to inflation as retail fuel prices are unchanged since May 2022, except for minor reduction in March 2024.

Further rise in crude oil prices is likely to have an impact on the forex reserves, which stood at an all-time high of $692.296 billion and it could depreciate the rupee. This may in turn elevate the cost of imports, squeezing corporate profits and triggering a meltdown in markets. The equity market is down around 5 percent since October 1.

In the last two months, India’s CPI inflation has remained lower because of favourable base effect, despite boiling food prices. Inflation rose moderately to 3.65 percent in August from 3.6 percent a month back. That said, CPI inflation print declined to a 59-month low of 3.5 percent in July, which was below the Reserve Bank of India’s (RBI) target inflation band of 2–4 percent.

The RBI, however, preferred to remain cautious on the inflation front, particularly on food prices.

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. “But with food inflation pressures showing little signs of abatement in the near-term, and household inflation expectations picking up, monetary policy has to remain vigilant to potential spillovers of food price pressures to the core components.”

Economists further 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.