Has the reopening of the Strait of Hormuz removed the biggest near-term upside risk to the RBI’s inflation projection of 5.1%?
When the MPC put out its inflation and growth forecasts for FY27, the average inflation forecast was 5.1%, with upside risks, while the growth forecast was 6.6%, with downside risks. There were two important factors behind these risks. One was the West Asia crisis with its repercussions for fuel cost, INR exchange rate and current account deficit. The second was El Nino. These risks have adversely affected inflation and growth forecasts. With the reopening of the Strait of Hormuz, the first risk has come down significantly, reducing the upside risk to inflation. At the same time, crude oil and energy prices are unlikely to return to pre-conflict levels in the near term for two or three reasons. One is the likely persistence of a mismatch between demand and supply of crude oil due to damage to oil infrastructure in the Gulf. The second is the logistics and shipping cost. As per reports, vessel booking costs and insurance premiums are at multiple times the normal levels. So, there remains some upward pressure on energy prices, and to that extent, upside risk remains, though it has reduced substantially.
You mentioned El Nino. How do you see it impacting inflation?
It remains an important concern. El Nino will add to volatility in food prices, particularly pulses, fruits and vegetables. Prices of cereals and staples should remain stable as we have adequate stocks, and cold storage and transportation capacities today are much better than in the past El Nino episodes. Further, no increase in fertiliser prices has reduced the input cost pressure for agriculture. Going by available reports, kharif sowing patterns appear normal so far. From a monetary policy point of view, my hope is that the El Nino effects remain range-bound so that we can see through it as a supply-side shock. Incoming data will be critical for assessing the overall El Nino impact.
But do you still see upside risk to the 5.1% estimate?
Yes, theoretically, on three counts. First, parties involved in West Asia failing to hold the truce, and flare-ups remain a possibility. I would like to believe that the active conflict is behind us. Second, although El Nino’s impact is expected to be confined to pulses, fruits and vegetables, those prices can display high volatility. Third, we must remain vigilant about the second-round effects of higher energy prices and rupee depreciation. Research suggests that 10% INR depreciation can lead to a 40-50 basis points increase in retail inflation. But I expect these effects to remain moderate. The Centre’s decision to allow only limited increases in retail gas, diesel and petrol prices has protected citizens from the full direct and indirect impacts of the crisis.The RBI lowered its growth projection to 6.6%. What is your assessment now?
The easing of the West Asia crisis certainly reduces the downside risk to the 6.6% growth forecast. Growth could turn out to be higher depending on three factors. One is how El Nino affects the spread of the monsoon and rainfall. It will affect agricultural growth, rural incomes and rural demand, and through these channels, overall GDP growth. The second is uncertainty related to the Gulf crisis. Any moderation in El Nino effects and resolution of geopolitical uncertainty will further reduce the downside risks to growth. Operationalising the free trade agreements (FTAs) signed with 37 countries will boost exports and FDI, and thus growth.
The Indian economy was seen to be in a Goldilocks phase before the conflict. Do you think the West Asia crisis has dented the growth momentum?
To an extent, it has. When the crisis unfolded, we were in a Goldilocks phase (low inflation and high growth rate), and some of that momentum is still playing out. Private investment in January-March 2026 showed ample evidence of improvement, both in actual investments and project announcements. Manufacturing capacity utilisation at 75.2% is above its long-term average. If you look at FMCG rural sales, two-wheeler sales, passenger vehicles and tractors, wholesale sales have all registered robust growth in April-May. This suggests demand momentum is still there. Latest data on credit growth rate and advance tax payment by corporates also suggest continued momentum. However, since the start of the crisis, global growth forecasts have been revised downwards, affecting our exports and growth rate. Moreover, the uncertainty index remains elevated, prompting companies and investors to adopt a wait-and-watch approach towards expansion plans.
What should be the policy priority? Does slowing growth take centre-stage following the easing of tensions in West Asia?
First, it is important to recognise that real interest rates are already extremely growth-supportive. With inflation forecast for FY27 at 5.1% and the repo rate at 5.25%, real interest rates are extremely low. Adequate liquidity adds to the pro-growth of the monetary policy. My hope is to maintain this if the inflation trajectory improves. I have several reasons to feel optimistic. Crude oil prices are showing greater stability, with futures showing a tilt towards pre-conflict levels. It is in the interest of the countries involved not to return to a situation where crude oil supplies are disrupted. Another risk regarding the imported inflation, which is a self-fulfilling downward spiral in the rupee exchange rate, has been resolved. The rupee has been under pressure since the beginning of the Gulf crisis. But the RBI’s recent measures to facilitate greater foreign portfolio investment in sovereign debt, combined with the government’s tax relief measures, concessional forex swaps to boost FCNR deposits and ECBs by banks and PSUs, have eased pressure on the rupee. With this, the pressure on prices due to imported inflation due to INR stress is almost behind us. Therefore, I feel our inflation trajectory will broadly remain as forecast, or may even improve if the El Nino impact is limited. If that happens, the monetary policy can continue to support growth.
Are these measures adequate, or are more interventions required?
I think they are adequate. The Centre’s and the RBI’s measures in the first week of June have effectively broken the downward spiral for the rupee triggered by the concerns over CAD and elevated hedging by investors and importers. The rupee has already started to strengthen against the USD, reducing pressure on our import bill and current account deficit, not just through crude oil but also through other imported metals. You can also see that yields on Indian sovereign securities have come down across maturities. Overnight index swap (OIS) rates have also softened, reflecting confidence in the rupee and the Indian economy. Data from the Clearing Corporation of India Ltd. (CCIL) confirm that hedging costs and overall forward activity have cooled down significantly since mid-June. Going forward, it is very important to address the other avoidable hindrances to FDI and FPI investors. The valuation methodology used to apply deeming provisions of Section 56(2)(x) of the Income Tax Act is one of the cases in point.
There have been suggestions that the MPC should also keep an eye on rupee depreciation, with some arguing for a rate hike. What is your view?
My view is that the MPC mandate under the Flexible Inflation Targeting regime is appropriate. The decisions regarding repo rate and liquidity levels are guided primarily by the need of the domestic inflation-growth dynamics, whereas the INR exchange rate is mainly market-determined, supported by volatility targeting through RBI interventions and forex regulation. This separability principle has served us well, providing the required autonomy to the monetary policy. Using interest rates to address exchange rate pressures is not a prudent policy choice. Measures and reforms to encourage greater capital inflows through the portfolio route and FDI, such as those rolled out by the RBI and the Centre recently, are much more appropriate and effective. Interest rates have a limited impact in this context but can impose high costs on the economy.