RBI: Tough calls ahead
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The Monetary Policy Committee (MPC) of RBI announces next policy on August 5, 2026. Between June and August policy, geo-political uncertainties have intensified.The fragile agreements of peace and ceasefire between the US and Iran did not last long. Escalating attacks and the blockade over the Strait of Hormuz pushed the brent crude price above $100 per barrel again with an upside trend.Benign inflation for the past many months provided the MPC enough headroom not to increase repo rate, even when rupee depreciated significantly. But the situation has been changing quite rapidly, with upside pressures concurrently in WPI and CPI inflation and muted growth prospects.Story so farCPI headline inflation breached the 4 per cent target in June. Further, the effect of low and declining base will keep inflation up for many months. RBI’s own forecasts show higher probability of CPI inflation crossing the 6 per cent upper tolerance bound.At the same time, downside risks to the domestic growth continues. Nominal GDP has been declining steadily – from 11 per cent in 2023-24 to 8.9 per cent in 2025-26. Low overall inflation for the past many months primarily helped showing a reasonably high real GDP growth. High frequency indicators including IIMA’s Business inflation Expectation Survey (BIES) indicate declining sales and profit margin expectations. The depreciation pressure on rupee hasn’t eased either even with consistent intervention by the central bank.What would MPC do against this persisting supply shocks, slowing growth and increasing inflation scenario?The ‘scissor’ effectIn February 2026, the NSO revised the CPI base from 2012 to 2024. With consumption weights based on the Household Consumption Expenditure Survey 2023-24, the food weight in CPI declined from 45.86 per cent to 36.75 per cent. However, in the new series, contrary to expectation, the correlation between food inflation and CPI-headline inflation has indeed increased and stood at 0.97.In new series CPI headline and food inflation trends show some interesting features. There are times when food inflation fall is sharper compared to headline inflation and vice versa. During past two years, this has happened twice when food and headline criss cross each other: called the ‘scissor effect’ (Chart 1). This dichotomy has direct policy implications particularly when food prices decline faster and becomes negative. Consequently, farmers adapt their expectations to the low prices and adjust next period production accordingly. This results in sharp increase in food inflation in the next period, surpassing that of headline inflation.The WPI headline crossed 9 per cent in June 2026 (new series with revised base 2022-23). Will this increase in prices in wholesale market translate into higher prices in retail market? As the price index is a weighted sum of price relatives, it is likely to show up, at least in common items.For example, the correlation between WPI and CPI food inflation is 0.97 in the new series. Ensuing CPI food inflation therefore is likely to be higher with WPI food inflation is already hovering above 6 per cent. Further, the fuel inflation has skyrocketed, touching close to 30 per cent during last quarter.This surge in the universal intermediate will raise input costs, with expected spill-overs to other components of WPI. Expectedly, WPI non-food manufactured products (NFMP) inflation, which potentially manifests as the core inflation of the manufactured goods, has been running over 7 per cent for the past three consecutive months.Also, WPI is closely linked with GDP deflator (correlation over 0.80). It is likely the broad-based price pressures both in CPI and WPI will push up the GDP deflator substantially, resulting in subdued real GDP growth.Rate hike likely?First, with Fed keeping rates unchanged but divided house pledging to ‘deliver price stability’, rupee would get support from a higher interest rate. From February 2025 till date, WPI and rupee show a correlation of 0.81: pass-through of supply side shock to domestic inflation needs to be contained.While rising crude prices almost invariably translate into rupee depreciation, periods of crude price correction do not necessarily halt rupee depreciation, as capital account outflows can outweigh the gains from an improving current account.Second, the high credit growth (with FCNRB leading to cheaper deposits), sharper increase in inflation, and persisting adverse supply shocks indicate playing with the traditional interest rate instrument. As monetary policy is forward looking and there is a long lag in transmission, a 25-bps increase in repo is not a distant possibility.Das is ICICI Bank Chair Professor, Indian Institute of Management Ahmedabad (IIMA), Roy Trivedi is Associate Professor, National Institute of Bank Management (NIBM). Views expressed are personalPublished on August 3, 2026
