Monetary Policy shifts gear, lays emphasis on containing supply-side shocks | Markets News

Disclaimer: Mumbai-based Garima Kapoor is Deputy Head of Research and Economist, Elara Securities. Views are her own. The RBI Monetary Policy Committee (MPC) raised the policy repo rate by 25 basis points (bps), in line with our expectations, responding to the broadening and potentially upside risks to inflation, amidst resilient domestic growth, hawkish global DM central banks and geopolitical backdrop. 

The central bank has also changed its monetary policy stance to ‘calibrated tightening’ from neutral in 4-2 vote and has taken rate cuts off the table in the near term. 

Going ahead, another 25bp hike in December by the RBI remains our base case, but probability of another 25bps hike (75bps total including the October hike) has gone up substantially. 

The principal drivers of our call are: 1) headline inflation is moving higher while growth risks have softened; 2) core inflation and the breadth of price increases are rising; 3) deficient rainfall raises food-inflation risks; 4) elevated crude, commodity and freight costs are increasingly being passed through by firms; 5) resilient domestic growth provides room for monetary tightening; and 6) renewed tightening by the Fed, BoJ and other central banks limits the RBI’s policy flexibility.

Inflation

The Governor acknowledged that price pressures are increasingly extending beyond food and fuel. The RBI projected core inflation at 4.4 per cent versus 4.3 per cent earlier and headline CPI at 5.2 per cent vs 5 per cent earlier with 2HFY27 averaging near 6 per cent. 

Domestic demand and credit growth remain sufficiently resilient for faster pass through providing the RBI room to prioritise inflation management. We, therefore, expect the policy stance to remain focused on ensuring that the combination of food, energy and imported cost pressures does not generate a more persistent rise in underlying inflation. 

At the same time, firms are facing renewed cost pressures from energy, freight and industrial commodities. Food inflation risks are partly offset by administrative measures. The government has reduced import duties on palm, soybean and sunflower oils after domestic vegetable-oil prices rose sharply, which should cushion some pressure on edible-oil inflation. 

On the energy side, the direct CPI impact of higher crude may remain partly moderated by domestic administered pricing, but the indirect effects through transportation, manufacturing and services costs are likely to become progressively important. The risk is therefore is tilted to upside for second-round transmission into underlying inflation expectations and corporate pricing behaviour. 

Growth

Growth remains resilient enough to absorb moderate tightening: Domestic activity remains supportive, allowing the MPC to act pre-emptively on inflation without materially jeopardising the growth outlook. Resilient household demand, continued investment activity, strong services momentum, and robust credit growth should keep underlying economic activity firm. Real GDP growth revised FY27E growth to 7.1 per cent, compared to 6.7 per cent seen earlier. Consequently, we do not view a cumulative 50-75bp tightening cycle as sufficiently restrictive to derail the growth trajectory. 

However, downside risks to growth exists in the sidelines. Prolonged geopolitical conflict could simultaneously raise supply chain bottlenecks, input costs and weaken external demand, while deficient rainfall could weigh on agricultural output and rural purchasing power. Therefore, beyond the December hike, we expect the RBI to become increasingly data dependent, balancing inflation persistence against the lagged transmission of tighter financial conditions. 

Global central banks

Global monetary conditions have become considerably less supportive for emerging market (EM) central banks. The US Federal Reserve raised the Fed Funds target range by 25bp to 3.75–4.00 per cent in September, citing still-elevated inflation. We expect 2 more hikes (2x25bps=50bps) from the Fed in Dec-26 and in Q1CY27. The BoJ has also continued monetary-policy normalisation, with another policy hike announced at its September meeting, and potential 2-3 hikes from BoE and ECB expected over upcoming quarters. Taken together with tightening by several Asian central banks, this reduces the relative carry available on INR assets if the RBI remains on hold.

We, therefore, expect developed market (DM) monetary policy to remain an important constraint on the RBI. If DM yields remain elevated and policy rates move higher, maintaining an adequate interest-rate differential becomes increasingly relevant for capital flows, INR stability and domestic financial conditions.