Retail inflation cools down but October RBI rate hike imminent: SBI report

The Reserve Bank of India (RBI) is likely to raise its key policy rate by 25 basis points in October despite a moderation in retail inflation, according to the latest SBI Ecowrap report.

The report said the possibility of a larger 50-basis-point increase cannot be ruled out, particularly in view of pressure on the currency. However, such an aggressive move could be difficult for the central bank to justify as inflation remains within a relatively moderate range.

“Even though CPI inflation has cooled off, we believe an October rate hike of 25 bps is imminent,” the report said, while raising the possibility of a 50-basis-point increase.

The report pointed out that a currency crisis would normally warrant a stronger policy response. However, the RBI's inflation-targeting framework makes a sharp rate increase more difficult to defend when consumer inflation remains under control.

According to data released by the Central Statistics Office (CSO), India's retail inflation declined to 3.69 per cent in August from 4.17 per cent in July, mainly due to softer food prices. Despite the monthly moderation, inflation remained higher than the 3.28 per cent recorded in August 2017.

The SBI report noted that the RBI is facing a difficult policy balancing act, with the central bank having to manage both currency pressures and inflation. While higher interest rates could help support the rupee and contain inflationary risks, they could also increase borrowing costs for businesses and consumers and potentially weigh on economic activity.

The report also highlighted the possibility of inflation falling below 3.5 per cent in November 2018, adding another layer of uncertainty to the central bank's policy decision.

With the October policy meeting approaching, the RBI's challenge will therefore be to strike a balance between maintaining price stability, supporting the rupee and avoiding an excessive tightening of monetary conditions.