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Inflation trajectory holds key for further rate hikes: Aditi Nayar, ICRA | Markets News

by admin October 7, 2026, 12:57 pm 200 Views

Disclaimer: Aditi Nayar, Chief Economist, Head – Research & Outreach, ICRA; views expressed are her own.

The Monetary Policy Committee’s (MPC) fourth bi-monthly meeting for FY2027 panned out in line with ICRA’s expectations, with the policy repo rate being unanimously hiked by 25 bps to 5.50 per cent. As we had anticipated, the policy stance was changed, albeit non-unanimously, to “calibrated tightening” from neutral, thereby underscoring that the next move on rates would either be a hike or a pause. This marks the onset of the monetary tightening phase, after a gap of three years. Additionally, the tone of the policy document was clearly hawkish, highlighting the elevated risks to inflation since the last meeting in August 2026.

The policy tightening was accompanied with a 20 bps upward revision in the MPC’s inflation projections for FY2027 to 5.2 per cent from 5.0 per cent in August 2026, amid a 10-20 bps increase in the forecasts across Q2-Q4 FY2027. Additionally, the projection for Q1 FY2028 was raised sharply by 30 bps to 5.6 per cent, implying that the CPI inflation would hover ~5.8 per cent for three quarters in a row.

Interestingly, while the forecast for the headline print was raised by 20 bps, that for core inflation was increased by just 10 bps to 4.4 per cent compared to the previous meeting. This implies that the non-core portion, particularly food, has seen a larger upward revision, amid the broad-basing of price increases within this segment. This is consistent with our expectations, given the sub-par and uneven monsoons, and the large lags in reservoir levels vis-à-vis the historical averages in some parts of the country, which do not portend well for the upcoming rabi season.

Our base case pencils in the headline CPI inflation to average at 5.0 per cent in FY2027, with risks tilted to the upside, as against the MPC’s projection of 5.2 per cent with balanced risks. However, our base case pencils in an average crude oil price of $85-95/bbl in H2 FY2027 and assumes unchanged Retail Selling Prices (RSP) for petrol and diesel. If the crude price remains elevated through H2 FY2027, this will prompt the need for RSP hikes, given the sizeable marketing losses of the OMCs. In such a case, the CPI inflation could rise to 5.3-5.5 per cent in FY2027, depending on the timing and the extent of the RSP increases.

On the growth front, the Committee expectedly raised its real GDP growth projections for FY2027 to 7.1 per cent from 6.7 per cent in the August 2026 policy. This was aided by the stronger-than-expected performance in Q1 FY2027, as well as sizeable increases in the growth projections to the tune of 80 bps for Q2 and 40 bps for Q3 FY2027. With this, the GDP growth projections are anchored in a narrow 40 bps band between 6.8 per cent and 7.2 per cent for Q2 FY2027 through Q1 FY2028.

While we broadly concur with the MPC’s growth projections for FY2027, we believe that there are sizeable risks to the outlook, in contrast with the Committee’s assessment of risks being evenly balanced. The outlook for agriculture and rural demand remains precarious owing to the sub-par monsoon rains. While kharif sowing was only ~1 per cent lower than the year-ago levels, and was in line with normal levels, yields may be impacted owing to the spatial and temporal unevenness in rainfall. Besides, significant lags in reservoir storage in the southern and northern regions don’t augur well for rabi sowing and output. Overall, weak crop prospects and growing inflation risks may weigh on consumption demand in the second half of the fiscal.

Secondly, global energy and commodity prices have remained stubbornly high. This is set to impact corporate margins in Q2 and Q3 FY2027, notwithstanding healthy volume growth across high frequency indicators in July-August 2026, which would have implications for GDP growth. Additionally, the elevated base owing to the GST rate rationalisation in September 2025 would also optically dampen volume growth in H2 FY2027. Overall, we expect GDP growth to print at 7.1 per cent in our base case, in line with the MPC’s forecast, although this could come in lower at ~6.8 per cent if oil prices average around $100/bbl through H2 FY2027.

With GDP growth expected to remain healthy and increased supply side price pressures, concerns around the generalisation of inflation remain paramount, with some evidence of the same in the CPI inflation and diffusion prints so far. Looking ahead, we expect another rate hike of 25 bps to materialise in the December 2026 meeting, amid expectations of increased generalisation of inflationary pressures. Thereafter, we do not foresee the need for further rate tightening in 2027, unless there are sizeable negative surprises on the inflation front.

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