RBI policy decision tomorrow: Why central bank has its task cut out

The Reserve Bank of India (RBI) faces a pivotal challenge as it prepares to unveil its monetary policy decision on August 10, given the sharp uptick in inflation.

In June, retail inflation surged to a 3-month high of 4.81 per cent, following a significant decline in the previous month to a 25-month low.

Inflation spike

Economists project that July's inflation could breach the 6 per cent mark, attributed to substantial price hikes in essential commodities like vegetables, fruits, pulses, cereals, and even milk.

If inflation does rise above 6 per cent in July, it would mark a nearly two per cent or 200 basis point hike in inflation in just 2 months, and would be a blow to RBI’s strategy to tackle inflation.

And if economists are to be believed, inflation is expected to rise further over the next few months due to supply shortages, triggered by heavy rainfall in key crop-producing regions.

RBI’s game plan

This puts the RBI in a tricky situation and complicates its fight against inflation, which it aimed to bring down to its medium-term target of 4 per cent. But it may now struggle to keep it below its upper limit of 6 per cent.

While RBI Governor Shaktikanta Das had previously warned about a sudden rise in inflation, the magnitude and pace of the rise could pose a greater challenge than earlier expected.

Most economists suggest that the RBI is going to sit tight and hold the key repo rate at 6.50 per cent tomorrow while maintaining a hawkish stance.

"Amid accelerating food inflation, the RBI is likely to keep the repo rate unchanged at 6.5% at its monetary policy meeting outcome due tomorrow. We believe that the recent surge in vegetable prices is transient and would be interesting to see whether the central bank resorts to any upward revision to its consumer price inflation forecast," said Shreyansh Shah, Research Analyst, StoxBox.

The hawkish stance could be a sign of future rate hikes, which would become a necessity in a situation where inflation keeps rising. And most economists expect inflation to remain elevated during the second quarter.

Some economists had even predicted a 25 basis points hike over the next two policy reviews if essential item prices keep surging. "Though the RBI may take some comfort from the declining core inflation, we expect it to continue with its hawkish stance, especially amid the prevailing global uncertainties and the likely occurrence of El Nino," Shah added.

Shah also said it would be interesting to see the tone of policymakers, following the recent decision of the US Federal Reserve to resume interest rate hike.

On the possibility of a rate cut, he said, "While a rate cut still looks far away, probably into the next fiscal year, the RBI has a task at hand to manage inflation without jeopardizing economic growth which has been the fastest amongst major economies around the globe."