Ahead of the curve in managing inflation

Headline inflation has been ticking up in recent months, and is above the 4% RBI target. Price pressures are largely from volatile food and fuel components due to an erratic monsoon and oil supply disruption from West Asia. Wholesale price inflation is approaching 10% as global supply chain disruptions feed into input costs. But core inflation, minus food and fuel, is relatively stable and within RBI's comfort zone.

Interest rate and liquidity management tend to look through episodic spikes in food and fuel inflation, unless these feed into a generalised phenomenon. RBI projects inflation for 2026-27 at 5%, with a peak in Q3 within its 6% tolerance band. The stance of RBI's monetary policy committee will be informed by resilient economic growth as well as the unfolding inflation scenario.

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A surge in dollar inflows through the special FCNR(B) scheme shouldn't add to inflationary pressure. RBI actively manages liquidity to accommodate forex flows. It will drain excess liquidity to prevent the economy from overheating. The excess liquidity with banks on account of bulging dollar deposits will be drained through enhanced sales of gilts by RBI. Stabilising effects of the dollar inflow on the rupee also contribute to lowering of imported inflation.

This is well within RBI's playbook after having conducted a series of dollar mopping-up exercises over the decades. Sterilising domestic liquidity from these surges is a part of that exercise. The premature close of the special FCNR(B) scheme indicates the vigil the central bank is keeping on liquidity.

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RBI is unlikely to be behind the curve in managing inflation, after having had to explain its inability to control it within the mandated band following the Ukraine conflict.

If India maintains its economic momentum, there is a likelihood the interest rate upcycle could be advanced. However, on current indications, growth is losing steam as inflation remains within manageable limits. RBI is known for trying to minimise the growth sacrifice as it maintains price stability.