The Reserve Bank of India's (RBI) policy response to the ongoing energy price shock is likely to be challenging due to multiple trade-offs involving inflation, growth, liquidity and currency stability, according to a report by Emkay Research.
The report highlighted that there is no straightforward policy approach to deal with an energy-driven shock, especially when inflation remains relatively benign but risks are rising due to second-round effects.
It stated "RBI's battle unlikely to be easy, FX and rates trade-offs".
It noted that before the conflict, the RBI's focus was on improving monetary policy transmission, particularly in the bond market, supported by ample liquidity that kept overnight rates below the policy rate.
However, the current situation has become more complex as rising oil prices are now influencing inflation expectations, growth outlook and financial conditions. While direct pass-through of oil prices remains limited due to managed fuel pricing, indirect effects are becoming more significant.
The report said that the central bank faces a difficult choice between supporting growth and controlling inflation, while also managing currency pressures.
The bar for a conventional rate hike remains high given that the shock is supply-driven, but at the same time, the RBI may need to reassess its liquidity stance.
It added that the Indian rupee continues to remain under pressure despite consistent foreign exchange interventions, largely through forward markets. While these interventions have helped stabilise the currency, they have also delayed liquidity tightening.
At the same time, the RBI has been supporting bond markets through purchases, keeping yields in check. However, the report noted that a sharp policy response in the form of raising interest rates to defend the currency appears unlikely at this stage.
The report also highlighted that prolonged disruptions in energy supply due to the Iran conflict could significantly impact India's macroeconomic outlook.
It revised its baseline forecast for FY27, assuming an average Brent crude price of USD 80 per barrel, with higher pressure expected in the first quarter.
As a result, GDP growth for FY27 has been trimmed by 0.4 percentage points to 6.6 per cent, while inflation has been revised upward to 4.3 per cent. The current account deficit (CAD) is also expected to widen to 1.7 per cent of GDP.
It added that the final impact on growth, inflation and fiscal position will depend on how the burden of higher oil prices is shared among oil marketing companies, the government and consumers.
So the report outlined that the RBI's policy path will remain complex amid rising external risks, currency pressures and the need to balance growth and inflation concerns.
Source Name : Economic Times