RBI MPC must raise rates as inflation and external risks rise

All in all, the Indian economy has done exceptionally well, notwithstanding the multiple shocks it has faced. It is advancing ahead on a resilient growth equilibrium of 7%-plus, that is spatially broad-based, sectorally diversified, and underpinned by rising productivity, while steadily working to break into a 8%-plus equilibrium. This is quite a feat for a large emerging market, and makes India stand out in its asset class.'

That was Poonam Gupta, RBI deputy governor in charge of monetary policy, speaking at the 13th State Bank of India Banking and Economics Conclave, less than a fortnight before MPC meets today to decide whether it's time to take the punch bowl away. In the words of William McChesney Martin Jr, US Fed chairman from 1951 to 1970, the central bank's job is like 'the chaperone who has ordered the punch bowl removed just when the party was really warming up'. Martin holds the record as the chair with the longest tenure ever. We now know the reason why. He had his sights firmly set on the primary responsibility of the Fed: price stability.

In India, however, if there are any worries that inflation would play spoilsport, neither the deputy governor nor MPC, at its previous meeting, gave any sign of that. Unlike in the past, when worries on the macroeconomic front were mostly on the external front, the punch bowl is still in play. GoI has taken the tab for higher international oil prices so that the pinch of higher prices in sectors like transport is noticeably absent.


It has also allowed RBI to buy time on the external front with its special FCNR(B) scheme that brought in dollars. Consequently, the fact that in the last 2 yrs, the capital account surplus has fallen short of CAD, resulting in a negative BoP of about $5 bn in 2024-25 rising to touch $23.6 bn in 2025-26, evoked almost no comment.

The net result - that 'getting monetary policy right is RBI's paramount responsibility' - seems to have been lost sight of. This, even though, by its own admission, India faced a tough situation. On trade, it had faced among the highest tariff rates the US had imposed on any partner country.

As a large net oil importer, it has been particularly exposed to the oil supply disruptions in West Asia and price shocks. Agriculture is a significant part of the economy, and El Nino is a huge risk. The rainy season has ended with the summer monsoon rainfall during the June-Sept period recording a deficit of nearly 13%. Significantly, this is the 4th-lowest seasonal rainfall since 2001, and the 13th-lowest since 1901.

Yet, on the face of it, Gupta is right. The economy seems to be doing well, though financials couldn't be worse. Oil prices are range-bound above the $100-a-barrel mark, the rupee is weaker, the 10-yr yield is higher, and the surplus occasioned by RBI's swap window might be keeping banks awake, but the hour of reckoning is yet to come. As far as the real economy is concerned, industrial production rose 8% in August against a 4.7% expansion recorded a year ago. None of this suggests an economy that might be in trouble a few months down the line.

It remained for finmin to express a contrary view. In its latest monthly review of performance for September 2026, the ministry said, 'Festive demand and higher input costs could add to near-term price pressures', while warning that 'geopolitical tensions and elevated crude oil prices could also add to imported inflation pressures'.

The fact is, India's BoP pressures are likely to persist despite a surge in forex inflows through RBI's special swap window, as seen by the weakening domestic currency, even as higher imports, and higher global interest rates and intensifying competition for foreign capital could strain the external account. RBI's concessional forex swap programme has provided India with significant near-term room to manage external pressures. But it cannot be viewed as a permanent solution.

In such a situation, it is RBI's job to voice caution. The US Fed, European Central Bank and Bank of Japan have raised rates in response, the first in response to a booming economy that, like the Indian economy, seems to defy logic, and the other two in response to a slowing one.

Many drivers of inflation - some good (strong growth) and some bad (energy supply disruptions, tariffs, deficits) - are beyond RBI's control. But incremental increases in borrowing costs can help address supply-demand imbalances. Sure, central banks are never as effective in restraining supply-induced inflation. Higher interest rates will not reopen a blocked strait, replace a sanctioned supplier or mend a trade relationship, as Swati Dhingra, external member of Britain's MPC, warns.

But they will, at the very least, restrain second-round effects. And, most important of all, it will not be for want of central bank action. And that is what MPC needs to ensure when it starts its 3-day meeting today. It must raise rates.