The decision by the US and Iran to halt the war is likely to give the six-member committee that sets India’s interest rates some breathing room, easing concerns over oil-led inflation that had clouded its outlook. Until now, the panel had been grappling with the uncertainty over when and how the over three-month-old war would end.
Experts are also quick to caution that while a breather could be in the offing, policymakers are unlikely to lower their guard just yet.
The peace deal—details of which remain patchy—is expected to be signed on Friday and will end the chokehold on shipments in the Strait of Hormuz, a narrow conduit through which about one-fifth of global oil supply passes. For India, which imports about 90% of its crude oil needs, this means easier access and lower prices. prices on Monday fell to $83.88 after the announcement.
In June, while holding interest rates, the ‘s monetary policy committee (MPC) reiterated that uncertainties exist around the conflict and its duration. Governor Sanjay Malhotra said the major risk today is how long these supply disruptions continue and what impact they have on prices.
Experts said the peace deal will serve as a breather as it brings some clarity, but there is little change in terms of their outlook on rates. While some still see rate hikes happening later this year, others continue to factor in a pause.
“The peace accord makes life easier for the MPC. It reduces uncertainty,” said Gaura Sen Gupta, chief economist at .
Sen Gupta said the problem for the rate-setting panel and the reason why they were sounding uncertain on inflation was imported inflation. “The fact that your freight costs will come down, metal prices and chemical prices, all of that will start easing off a bit, reducing the risk of generalized inflation.”
She believes the MPC will maintain the repo rate at 5.25% for now and look through transient supply shocks. According to her, the MPC expects retail inflation to reach 5.9% in the December quarter and not 6% and above. She said rate hikes will happen when inflation tops 6% and remains above that, not when it is somewhere near 6% in one quarter and then comes off.
Within tolerance
Under India’s inflation targeting framework, the monetary policy committee has to keep inflation at 4% with a tolerance band of plus or minus 2%. Inflation, as measured by the consumer price index (CPI), inched up to 3.93% in May, from 3.48% in April. Earlier this month, RBI raised its retail inflation outlook for financial year 2027 to 5.1% from 4.6% projected earlier.
“The final deal terms along with where oil prices average for the rest of the year become important. As of now, if oil settles at $85 per barrel, there is a downside risk for the inflation forecast,” said Kanika Pasricha, chief economic advisor at Union Bank of India.
Pasricha said if oil is at that level and rupee around the 93-94 per dollar range because of expected inflows on account of the recent norm easing in foreign currency non-resident () deposits, external commercial borrowing (ECB) and other schemes, then the MPC will be in a much more comfortable space to treat this as a temporary supply shock.
To expedite inflows of dollars, RBI decided to bear the hedging cost on FCNR deposits and opened a new hedging window to lower the cost of dollar borrowings by state-owned companies and banks.
“That said, as of now, we are still in the camp of a hike, of three rate hikes and normalization of rates back to 6% by the end of this financial year. The next hike could come in October,” said Pasricha.
Still not out of the woods
Others are not so convinced that this deal, or whatever little we know of it so far, moves the needle for monetary policy. Other uncertainties such as the prediction of a lower-than-normal monsoon linger.
“Nothing really changes for the MPC after the US-Iran truce announcement, except for the comfort that the pace of inflation may not accelerate,” said Madan Sabnavis, chief economist at Bank of Baroda.
Sabnavis’ scepticism stems from a clutch of reasons. First, there have been a number of times when the world felt Iran and the US were on the brink of peace, but it did not fructify. Second, even assuming the best possible case that this becomes a permanent peace accord and physical supplies of oil ease, it will take at least six months for things to normalize.
“If energy prices come down, it will definitely be a benefit for India, but the government might not lower retail prices immediately, even if crude prices fall,” said Sabnavis.
That is because the government might want to first cover up for all the losses that oil marketing companies made by not raising prices earlier. Unless the fuel retail prices come down, we might not see an impact on the CPI inflation, he said, pointing to the trickle effect on the broader economy.