As the Reserve Bank of India (RBI) convenes for its October policy meeting, both global and domestic risks have escalated since the August policy meeting. Domestic inflation briefly spiked to 7.4% in July but has since fallen to 6.8% in August and is expected to reach around 5.5% by December. Nevertheless, it remains well above the 4% target and is likely to persist at this level for several quarters. GDP growth in India has remained stable, with no immediate risks of disruption, while global economic slowdown risks persist. External sector risks have grown due to a more than 10% increase in crude oil prices and a strengthening dollar, which puts downward pressure on the Indian Rupee (INR).

Major developed market central banks are signaling a prolonged period of elevated policy rates, leaving the RBI with little room to adopt a dovish stance. It is expected that the RBI will maintain the policy rate at 6.5% and focus on keeping liquidity tight.

Brent crude oil prices have risen from a range of $85-90 to $95-100 in recent days, with the potential for further increases. The Dollar index (DXY) has strengthened from 102 to around 106, and the INR has moved from the 82.5-83 range to 83-83.5. While inflation in major developed markets is moderating, it remains above target levels, and central banks in these regions are adopting a hawkish stance. This credibility is enhanced by resilient economic growth.

From the RBI’s perspective, India’s interest rate differential with developed markets has continued to narrow as global central banks pause. The current account and capital flows are expected to face pressure for the rest of FY2024. The RBI has always been watchful of external balance pressures, which have become a more significant concern since the August policy meeting.

India’s inflation has experienced fluctuations, driven largely by vegetable prices. Core inflation has gradually declined and is expected to reach 4.5% in 3QFY24. However, the RBI will remain cautious due to several factors, including the persistence of elevated prices in some food items, potential adverse impacts of El Nino conditions on harvesting, and potential increases in raw material prices that can have a lagged impact on core inflation. Headline inflation is expected to remain well above the 4% target for the next few quarters.

With steady economic growth and mindful of external sector risks and inflation, the RBI is likely to stay watchful. Explicit rate actions will be considered if inflation expectations deteriorate and non-core components start affecting headline inflation. For now, the RBI will likely rely on implicitly influencing rates through tight liquidity conditions. The October policy is expected to reflect concerns about external sector pressures, caution regarding domestic inflation, and vigilance over domestic growth. The MPC is expected to maintain the repo rate at 6.5% with a stance of withdrawing accommodation while focusing on controlling external risks through liquidity and foreign exchange/bond market interventions.

The RBI’s approach is seen as a response to the current economic and global conditions, with a focus on maintaining stability and addressing emerging challenges.

Please note that the views expressed in this article are those of individual analysts and do not represent the views of Mint.

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