The RBI’s decision to lift the repo rate by 25 basis points to 5.50 percent should be viewed against the backdrop of a particularly challenging global economic environment. The decision is not solely driven by the recent movement in domestic inflation. It comes at a time when geopolitical tensions in West Asia have intensified, crude oil has moved above $100 a barrel, US Treasury yields remain elevated, the rupee has weakened and global financial conditions have become tighter.
At the same time, the domestic economy continues to demonstrate considerable resilience. In our view, the latest rate action is therefore better seen as a precautionary step to protect against future risks rather than as the start of a prolonged and aggressive tightening phase.
The current strength of economic activity has given the RBI the headroom to take this step. Real GDP expanded by a stronger-than-anticipated 7.8 percent in Q1 FY27, following which the RBI revised its FY27 growth projection upwards to 7.1 percent from 6.7 percent. The quality of this growth is equally encouraging, as private consumption, fixed capital formation, manufacturing and services have all supported the expansion. This provides an important cushion for monetary policy because an economy growing at close to 8 percent is better positioned to withstand higher interest rates than one operating below its potential.
The RBI is, therefore, not making a trade-off between inflation control and growth. Instead, it is taking advantage of strong economic momentum to address potential risks at an early stage.
At the same time, the inflation picture warrants greater caution than it did previously. Consumer price inflation moved up to 4.82 percent in August from 4.5 percent in July, while core inflation also edged higher to 4.2 percent. The RBI’s outlook is more significant, with headline inflation expected to average nearly 5.8 percent over the coming three quarters and FY27 inflation projected at 5.2 percent.