RBI MPC: Measured wait-and-watch strategy by Emkay Global Financial Services Ltd
The RBI expectedly held rates in its April policy, maintaining a neutral stance with a cautious tone, and flagged that a prolonged ME conflict could transmit supply shocks to demand pressures. The outlook now appears unbalanced—growth risks skewed to the downside (FY27: 6.9%) and inflation risks to the upside (4.6%), lending a mild stagflationary bias. That said, we believe that the bar for a conventional rate hike remains high, despite markets pricing in a more hawkish path. Such a move is likely to require a sustained supply shock that pushes CPI persistently above target, with energy costs feeding into core inflation and inflation expectations. While the ceasefire could be a turning point toward de-escalation, if tensions persist, macro-financial stability is likely to take precedence in the RBI’s reaction function. This shift is already visible in tighter FX trading norms, which have effectively raised the carry cost of long USD/INR positions to prohibitive levels.
MPC stays pat but cautious
As expected, the RBI MPC voted unanimously to keep policy rates on hold in the April policy, maintaining a neutral stance with a cautious tone. The central bank flagged Middle East oil risks, warning that if the conflict persists, supply-side pressures could spill over to demand-side pressures. Macro forecasts showed a stagflationary tilt, with the MPC seeing downside risks to the FY27 growth forecast (6.9%) and upside risks to the inflation forecast (4.6%)—marking an unbalanced outlook after a long time. The RBI also flagged risks of adverse spillovers from global financial markets, if the conflict drags, which could tighten domestic financial conditions and raise the cost of borrowing. In the presser, the governor welcomed the recent US–Iran ceasefire as a positive step, though uncertainty around supply normalization remains high. He emphasized that, from a macro perspective, the normalization of energy and commodity prices and supply dynamics matters more than the conflict itself, citing Ukraine as an example where, despite a prolonged war, the incremental supply impact has diminished over time.
Stagflationary tilt to growth-inflation outlook
Growth for 1HFY27 was revised down by 20bps from the February policy, admittedly, using the new GDP series. However, the growth forecast assumes that the adverse impact of the conflict would remain contained in the near term, while adding caution that escalation, wider spillovers, and uncertainty around energy infrastructure damage, along with weather shocks, would pose downside risks to domestic growth.
The 1HFY27 headline inflation was also raised mildly from 4.1% in February to 4.2%, while annual forecast at 4.6% likely reflects elevated energy prices and unfavorable base effects in 2HFY27. Apart from the risk of elevated energy prices from the West Asia conflict, potential El Niño risks were also noted as upside threats to inflation. The MPC projected core CPI for the first time, with FY27E at 4.4%, and noted that the underlying inflation momentum is even weaker when assessed through core CPI ex-precious metals, while also highlighting the risk of supply chain dislocations and its second-round effects.
The semi-annual Monetary Policy Report’s sensitivity analysis shows that assuming crude at USD95/bbl in FY27—USD10 above the RBI’s baseline of USD85/bbl—would lower growth to 6.7% (from 6.9%) and push headline CPI up to 5% (from 4.6%).
Bar for any conventional rate hike remains high
There is optimism that the ceasefire marks a positive step toward de-escalation. However, during periods of stress, policy responses are needed to broaden beyond inflation, with a stronger emphasis on macro-financial stability and a more assertive stance on FX management. Financial stability will no longer play second fiddle to the inflation-centric policy reaction function, if the crisis persists. This shift is already visible: amid a sharp currency decline and limited conventional policy options, the RBI has already tightened FX trading norms, effectively raising the carry cost of long USD/INR positions to prohibitive levels.
With these measures in place, we believe the bar for any conventional rate hike remains high. This contrasts with market pricing of ~3 hikes for FY27. It would require a sustained supply shock to drive headline CPI well above the target on a persistent basis, with energy price pressures spilling over to core inflation and, importantly, into inflation expectations. As of now, we see the conflict largely peaking in 1QFY27, with our inflation forecast tracking that of the RBI at 4.6%, with Brent at an average of USD80/bbl. We will be watchful of the system liquidity ahead. Sustained and sizeable unsterilized spot FX intervention ahead (if needed) would directly drain domestic liquidity and push up money market rates. At the same time, further expanding the RBI’s already-heavy net short forward position would also entail a cost. This will come to bite system liquidity with a lag, and pressure the spot INR with higher USD demand as contract maturity nears.
Developmental and Regulatory Policies:
Review of CRAR computation guidelines for commercial banks: Commercial banks are currently allowed to include quarterly net profits in CRAR calculations only if incremental NPA provisions have not deviated more than 25% of the average of the previous four quarters. This condition is now being removed, which will help banks from a reporting perspective.
Review of guidelines on Investment Fluctuation Reserve (IFR): The requirement to maintain IFR as a buffer against investment valuation losses will be discontinued, as this was losing relevance due to the new investment guidelines. This will help free up locked capital for banks.
Development of Term Money Markets: Non-bank participants (NBFCs including HFCs, corporates etc) will be allowed to participate in the term money market; this will help improve liquidity and participation in the market, while also providing an alternative funding channel for non-bank participants.
For More Emkay Global Financial Services Ltd Disclaimer http://www.emkayglobal.com/Uploads/disclaimer.pdf & SEBI Registration number is INH000000354
