Media365
The shift in stance by the RBI’s Monetary Policy Committee (MPC), accompanied by a rate hike in its October review, was hardly unexpected. Monetary policy is shaped principally by domestic growth and inflation dynamics, with global developments playing a secondary role. Recent developments on both fronts increasingly pointed towards a recalibration of policy. This year was marked by an unusual combination of shocks and uncertainties. Yet, despite the conflict in West Asia and unresolved tariff-related turbulence, India’s economy has remained remarkably resilient. Growth has stayed robust, while inflation, particularly core inflation, has thus far been relatively contained. However, the balance of risks has begun to shift.
Since the MPC’s August review, upside risks to inflation have become more pronounced. Three factors stand out.
First, the conflict in West Asia, marked by repeated cycles of escalation and de-escalation, has kept commodity markets volatile. Recent developments have pushed up crude prices again, with the Indian crude basket, as estimated by the Petroleum Planning and Analysis Cell, returning to its April peak. Reflecting this, we now expect crude prices to average $88-93 per barrel this fiscal, compared with our earlier forecast of $82-87 per barrel. Even if geopolitical tensions ease, crude prices may remain elevated as damaged infrastructure is repaired and depleted inventories rebuilt. In such a scenario, another round of pass-through to domestic petrol and diesel prices appears likely. While higher pump prices could temper demand and ease pressure on oil marketing companies, they would also raise inflation through both direct and indirect channels.
Food inflation represents a second major source of vulnerability. Food prices are the most volatile component of India’s inflation basket, and recent increases reflect both base effects and emerging supply concerns. To be sure, the relationship between monsoons and food inflation is not linear. Not every rainfall-deficient year has led to higher food inflation, and the government’s free food programme for nearly 800 million people, alongside healthy rice buffer stocks, provides an important cushion.
Nevertheless, the 2026 monsoon has ended with rainfall 13 per cent below the long-period average and over 42 per cent of districts in India classified as deficient. More importantly, the problem extends beyond the aggregate shortfall. The spatial distribution and timing of rainfall have been particularly unfavourable, making this one of the most disrupted monsoon seasons of the past decade. The implications extend beyond the current kharif season. Weak monsoons can impair rabi production by reducing soil moisture and reservoir levels. As of October 1, reservoir storage was 12.2 per cent below normal and 20.4 per cent lower than a year earlier. Crisil’s Deficient Rainfall Impact Parameter (DRIP) points to broad-based stress, with cotton, tur and bajra among the most vulnerable crops.
Intensifying El Niño conditions, combined with supply disruptions linked to the West Asia conflict, are exerting upward pressure on food prices worldwide. Particularly notable is edible oil inflation, driven by weather-related disruptions in Southeast Asia and rising biofuel demand. According to the World Meteorological Organisation, the probability of a strong El Niño extending into early 2027 is close to certainty, raising the risk of extreme weather events and supply disruptions. Given that India imports over 55 per cent of its edible oil requirements, elevated global prices and currency weakness continue to keep domestic edible oil inflation elevated at around 20 per cent. The impact of the monsoon on agricultural output and food prices, then, will remain one of the most important variables for policymakers to monitor this year.
Inflation risks, however, are no longer confined to supply-side shocks. Demand-side pressures also appear stronger than previously anticipated. GDP growth in the first quarter was not only above trend but also exceeded previous expectations, and the second quarter is also doing well. Reflecting this momentum, the RBI has raised its growth forecast for this fiscal to 7.1 per cent from 6.7 per cent earlier. Crisil likewise expects growth of 7.0 per cent.
The interaction between persistent supply shocks and strong demand warrants particular attention. Economic history suggests that when supply-driven price pressures coincide with robust growth, inflation often broadens beyond a narrow set of categories. Early signs of such generalisation are becoming visible in core inflation, with price pressures gradually spreading beyond food and fuel.
Global developments reinforce the need for caution. Bond yields in advanced economies have risen much more sharply than in India, reflecting persistent inflation and growing concerns over fiscal sustainability. Consequently, the spread between US and Indian 10-year government bond yields has narrowed to roughly 200 basis points, compared with over 400 basis points a few years ago, reducing the relative attractiveness of Indian government securities for foreign investors. At the same time, major central banks remain in tightening mode. The US Federal Reserve raised rates by 25 basis points in September, and markets continue to price in further tightening. The European Central Bank and the Bank of Japan have also maintained a tightening bias in response to persistent inflation pressures.
India’s liquidity situation adds another layer of complexity. The RBI’s efforts to mobilise foreign currency non-resident deposits have been highly successful, strengthening foreign exchange reserves and improving balance-of-payments resilience. However, these inflows have also injected substantial liquidity into the financial system. Consequently, financial conditions eased through August, and liquidity remains abundant. This creates a degree of tension, albeit transitory, between prevailing monetary conditions and the tightening bias increasingly warranted by growth and inflation dynamics.
Taken together, these developments explain the RBI’s policy shift. Inflation risks are becoming more broad-based, growth remains resilient, global monetary conditions continue to tighten, and domestic liquidity remains ample. Policymakers will need to remain highly vigilant on price developments. While future actions will remain data-dependent, the possibility of another rate hike this year can no longer be ruled out.
The writer is chief economist, Crisil
