Prudent approach: On the RBI’s interest rate-setting committee meeting

There was little room for the Reserve Bank of India (RBI)’s interest rate-setting committee to manoeuvre during its meeting in early August. Elevated global crude prices over the past few months had already pushed retail inflation beyond the central bank’s 4% target, with headline CPI rising to 4.38% in June, the highest in the current CPI series. While the outcome was a foregone conclusion, leading the RBI to keep the repo rate unchanged at 5.25% for the fourth consecutive meeting, RBI Governor Sanjay Malhotra’s post-MPC statement suggests that the central bank’s principal concern has, for some time now, been containing the fallout of mounting geopolitical uncertainties on India’s macroeconomic fundamentals. The recent dollar-rupee swap and the decision to absorb the hedging cost on fresh Foreign Currency Non-Resident (Bank) deposits are clear indications of the RBI’s focus. The objective is twofold: to maintain adequate domestic liquidity as the rupee weakens amid capital outflows, while shoring up foreign exchange reserves as the merchandise import bill swells on the back of elevated crude prices. Foreign exchange reserves have now climbed close to $700 billion, while FCNR(B) deposits have risen to around $40 billion and are expected to grow further before the scheme closes. The rupee, which until recently was the worst-performing Asian currency, has recovered to around ₹95.

However, the MPC’s assessment that inflationary pressures are not yet broad-based and remain largely confined to food and fuel may prove premature. Higher fuel costs have affected sectors including transport, food, travel, and tourism. Inflation in transport services more than doubled to 4.31% in June from 1.75% in May. Although the Centre cut commercial LPG prices for a second consecutive month in July, it is unrealistic to expect restaurants and eateries to pass on these savings immediately. Passenger vehicle manufacturers have also raised prices this year, reflecting higher input and logistics costs. While U.S. President Donald Trump has indicated a possible truce and a durable arrangement to secure navigation through the Strait of Hormuz, the Ukraine war continues to threaten supplies from Russia, India’s largest crude supplier. Even so, the RBI’s decision to prioritise growth while remaining alert to inflationary pressures from global supply shocks is underpinned by India’s relatively strong domestic fundamentals. Merchandise exports grew 15.5% year-on-year in June, consumption demand has remained resilient, and public and private investments continue to strengthen. Governor Malhotra’s assertion that future policy decisions will remain “data dependent” and that the RBI will adopt a “wait-and-watch” approach is arguably the most prudent course.