RBI Maintains Dovish Stance, Shifts Focus from Inflation to Growth Risks

 As expected, the Reserve Bank of India (RBI) has retained its dovish stance on liquidity. By stating it “will continue to be proactive in liquidity management,” the central bank signaled a soft policy approach rather than a hard one. Currently, liquidity is so abundant that overnight rates are trading well below the repo rate. Interestingly, the RBI also expressed concern that commercial paper (CP) and certificate of deposit (CD) rates remain elevated, highlighting pockets of tightness even amid surplus liquidity.

So, where is the risk of rate hikes? The RBI’s latest statement suggests it is not imminent.

The central bank raised its inflation expectations, citing the Iran war, but simultaneously voiced concern over growth—again, a predictable trade-off. The RBI has projected CPI inflation at 4.6%, though with upside risks. More notably, it lowered its growth forecast to 6.9%, flagging further downside risks due to fuel supply constraints.

However, one departure from the usual script was the RBI’s warning about financial market volatility posing an additional risk to growth. Even more striking was its acknowledgment that the Iran war could become systemic, noting that “an initial supply shock may potentially become a demand shock.” This suggests that growth fears are not merely transitory.

On a reassuring note, core inflation is projected at a modest 4.4%. The very fact that the RBI highlighted core inflation indicates its willingness to look through temporary spikes in headline CPI driven by agricultural and fuel shocks.

Final Takeaway

The Iran war will undoubtedly shape the RBI’s future trajectory. But it would be wrong to conclude that a prolonged conflict necessarily leads to higher rates. In fact, it could just as easily suppress growth, prompting lower rates. For now, it is too early to even discuss rate hikes.

Note on El Nino: The Governor’s speech also gave space to El Nino risks, which will drive conversations in the coming months. While significant, India’s strong cereal buffers mean these risks are considerably milder than in the past.