RBI warns Middle East war could worsen inflation outlook

The Reserve Bank of India (RBI) is still in wait-and-watch mode. What has changed is what it is waiting for.

Two months after its rate-setting committee argued against a pre-emptive policy move, the August minutes show the debate tilting more clearly toward higher rates if oil, food and other costs start spreading through the economy.

RBI governor Sanjay Malhotra said such a broadening of inflation could require monetary tightening, while deputy governor Poonam Gupta said there was no room for further easing.

That is a notable change in emphasis even though the Monetary Policy Committee (MPC) has not actually moved rates. It unanimously left the repo rate at 5.25% on 5 August and retained its neutral stance for a fourth straight meeting.

“We also need to be watchful as the risks of higher food, fuel and other input prices translating into a broad-based increase in inflation and de-anchoring of expectations persist,” Malhotra said in the minutes released on Wednesday, 19 August. “Any evidence of these risks materializing may need policy tightening.”

In June, the tone was rather different. Malhotra had said underlying inflation pressures remained subdued and preferred to “wait and watch.” Gupta argued against a “preemptive policy pivot,” while most of the committee wanted more evidence that higher oil and food prices were feeding into inflation elsewhere.

The RBI is still asking for evidence. It just has more reasons to be nervous about what that evidence may show.

Oil is one of them.

Brent crude was trading near $92 a barrel on Wednesday after gaining more than 3% this week as uncertainty around the Strait of Hormuz again raised questions about supplies from the Gulf. The war has made crude prices unusually volatile, with every development around shipping and negotiations capable of moving the market sharply.

For India, expensive oil quickly becomes more than an energy story. The country imports most of the crude it consumes, leaving inflation, the trade balance and the rupee exposed when prices rise.

The domestic currency closed at 95.7525 to the dollar on Wednesday, its weakest level in about three weeks. Traders said the RBI had again intervened through state-run banks to contain the decline. Markets are now pricing about 57 basis points of RBI tightening over the next year. One basis point is one-hundredth of a percentage point.

The MPC is not yet convinced that those pressures justify an immediate rate increase.

Malhotra said there was only limited evidence so far that inflation was becoming generalized. He wants greater clarity on how persistent the recent price increases prove to be and where inflation eventually settles before rates are changed.

Gupta reached much the same destination from a slightly different direction. Further easing was no longer warranted, she said, but global uncertainty and weather risks made an immediate increase unnecessary.

“The best course of action would be to wait and watch a bit more,” she said.

The room for waiting comes partly from inflation that, while rising, has not yet broken away.

Consumer inflation reached 4.45% in July, its highest in 19 months and the second straight month above the RBI’s 4% target. Food inflation increased to 5.52% from 5.32% in June. Core inflation, excluding food and fuel, held at an estimated 3.9%, suggesting that the price pressure has yet to spread decisively across the basket.

The RBI nevertheless expects the headline number to climb further.

At its August meeting, it trimmed its average inflation forecast for 2026-27 to 5% from 5.1%, but left its October-December projection at 5.9%. Growth, meanwhile, was upgraded to 6.7% from 6.6%.

That combination explains some of the MPC’s patience. Inflation is expected to get worse before it gets better, but domestic growth is holding up and underlying price pressures remain relatively contained.

The concern running through the minutes is what happens next.

RBI executive director Indranil Bhattacharyya said inflation was on a “clear upward trajectory” and would average 5.6% over the next nine months. Supply shocks, he warned, could produce second-round effects across the economy.

Those second-round effects are where an oil shock starts becoming a monetary-policy problem. Higher fuel and freight bills raise costs for businesses. If those costs are then passed on more broadly and begin influencing household inflation expectations, the RBI has a stronger case for responding with rates.

That risk has been hanging over the MPC since the war began, but its language has hardened.

At the June meeting, external member Saugata Bhattacharya was already warning that the balance of risks was shifting toward embedded inflation pressures. The rest of the committee was more reluctant to act before seeing how the conflict, oil prices and the monsoon developed.

By August, the distinction had narrowed. All six members still backed holding the repo rate at 5.25%, but the discussion was increasingly about whether inflation would become persistent enough to warrant tightening rather than whether the RBI had space to ease again.

That is also a reversal from where expectations stood barely three weeks ago.

A Reuters poll published on 27 July found economists expecting the RBI to keep rates unchanged through the rest of 2026, with the median forecast showing no move until at least early next year. At the time, many economists believed raising rates in response to a largely external oil shock would hurt growth without doing much to solve the source of inflation.

The market has since moved toward considerably more tightening.

The RBI itself is not there yet.

Its next policy meeting runs from 5 to 7 October. By then the MPC will have two more months of inflation data, a clearer picture of the monsoon and another stretch of oil prices to judge.

For now, the pause continues. But the August minutes make the direction of risk harder to miss.