RBI Raises Rates 25 Basis Points, Shifts To Calibrated Tightening

The Reserve Bank of India’s Monetary Policy Committee (MPC) has changed its policy stance to “calibrated tightening” from “neutral” while raising interest rates by 25 bps to respond to rising inflation. The change signals that the central bank is prepared to use the tools available to it to keep inflation in check.

The RBI now projects retail inflation at 4.9% in Q2, higher than its August projection of 4.7%. Inflation is expected to rise to 6% in Q3 before easing marginally to 5.7% in Q4. These projections come as global oil prices have again crossed $100 a barrel after a brief reprieve.

Oil prices and pressure on consumers

India’s oil marketing companies have so far held off on passing most of the increase in global oil prices on to consumers, likely following government instructions. However, the companies cannot withstand such fiscal pressures forever.

The impact of higher crude prices has already been severe enough, and a rise in petrol and diesel prices will likely send inflation spiralling. At the same time, a deficient monsoon is pushing up food prices and is expected to continue doing so for the rest of the year.

This combination leaves the RBI dealing with inflationary pressures that are largely coming from the supply side. When supply-side factors are the primary drivers of inflation, an interest rate hike can have only second-order and largely marginal effects on inflation.

The signal behind the rate hike

In these circumstances, the signal sent by the MPC becomes as important as the immediate effect of the rate increase. The MPC has used the latest policy review to try to dampen inflation expectations, which the source identifies as an important area of action.

Expectations of high inflation in the near future can become a self-fulfilling prophecy, independent of the factors that are driving prices higher. Against that risk, the 25 bps increase is described as a careful nudge rather than an inevitably ineffectual bludgeon.

The more significant signal, however, is the shift in stance from “neutral” to “calibrated tightening”. The policy question is no longer whether the RBI will raise rates at its next meeting in December, but by how much.

Growth faces a parallel test

The stance change also indicates that the RBI believes the economy can withstand tighter monetary conditions. The central bank has revised its GDP growth forecast for 2026-27 upwards to 7.1%, from the 6.7% projected in August.

That positive revision comes alongside expectations of weaker growth later in the year. All economic agencies had already been predicting a slowdown in the second half of the year, even before interest rates were raised.

The growth-inflation trade-off will therefore test the RBI’s judgement. Higher interest rates may also pause the ongoing exodus of Foreign Portfolio Investors (FPIs), giving the RBI some breathing room on exchange rate-related pressures.

The government’s role

The RBI has done what it can on inflation so far, but the next responsibility lies with the government. It has several tools to control food inflation, including strategic buffers, import and export controls, anti-hoarding measures and open market operations.

Those tools need to be used more effectively. The rate increase can help shape expectations, but the source makes clear that supply-side pressures will require action beyond monetary policy.

Source: The Hindu