Synopsis
India faces geopolitical turbulence despite strong economic fundamentals. The Reserve Bank of India's upcoming policy decision is crucial. Rising inflation and potential growth slowdown present challenges. The central bank must manage uncertainty, avoid premature tightening, and focus on domestic stability. Clear communication on currency management is vital to counter market fears and reinforce India's underlying economic strengths.
Starting points matter. India entered the current phase of geopolitical turbulence from a position of strength. A rare 'Goldilocks' mix - robust growth, contained inflation, a low current account deficit and ample foreign exchange reserves - had set the economy apart from most peers. That's the kind of macro backdrop policymakers usually wish for in a crisis.
And, yet, in a matter of weeks, the narrative in financial markets has turned sharply. Rupee has depreciated by over 4% - underperforming most EM Asian peers, and foreign portfolio outflows have approached $12 bn in March alone. Oil has risen for everyone in Asia. But the market reaction in India seems sharper.
In many ways, India's demonstrated resilience to repeated global shocks over the past decade is being under-appreciated. This points less to a deterioration in current fundamentals and more to a gap in confidence. That's why RBI's upcoming policy decision matters more than usual - not just for what it does but for what it says.
Since late 2024, RBI has been successfully navigating a tricky mix: external volatility, tariff-related uncertainties and shifting liquidity conditions at home. The inflation-growth trade-off in 2025 was manageable. The real challenge was keeping the rupee steady without tightening domestic conditions too much.
Now comes a fresh complication. Higher energy prices are likely to push inflation above earlier expectations - likely into the 4.5-5% range, with risks skewed upward. Second-round effects could linger, especially as core inflation gains weight in the new CPI series. At the same time, growth - just regaining momentum - may soften, slipping towards 6.5-7%, with risks skewed towards the downside. So, what must central banks do when classic stagflationary risks rise?
This is where things get murky. If the shock borne out of the US-Israel war on Iran remains largely about prices, as in the Russia-Ukraine war, the damage may be contained through proactive monetary and fiscal offsets. But if it evolves into a wider supply disruption, macro impact could look more like the pandemic. Right now, there's no reliable way to assign probabilities to either outcome and, as a result, there are no easy answers to the future path of monetary policy.
In such conditions, central banking becomes less about precision and more about judgement. Which is why RBI would be well-served by emphasising uncertainty surrounding the outlook, rather than signalling a definitive policy path. The central bank must also resist the temptation to sound hawkish.
Rate signals won't fix an imported inflation shock driven by oil. But they can tighten financial conditions, prematurely pushing up borrowing costs and dampening demand just as growth faces external headwinds. Indeed, the burden of addressing such shocks often lies more with fiscal policy than with interest rate adjustments.
Instead, focus should be on keeping domestic conditions stable - ensuring liquidity, anchoring bond yields and avoiding unnecessary volatility in money markets.
It's also worth reminding markets where things started. Inflation has been running closer to 2-3%, giving RBI sufficient runway before considering a change in stance. Equally, there's little to gain from rushing to downgrade growth forecasts. A more measured approach - highlighting risks, rather than rewriting the baseline - would preserve flexibility without feeding pessimism in an environment where macro-outcomes remain uncertain.
Then there's the currency. The idea that rupee should act as a 'shock absorber' sounds neat in theory. In practice, for an oil-importing economy, a rapidly weakening currency often does the opposite - it amplifies the inflation shock and invites further speculative 'depreciation bets'.
Recent measures to curb speculative positioning are unlikely to sustainably steady the rupee by themselves. What's needed isn't a new toolkit but clearer signalling for now. Markets don't need a target level. What they do need is to believe that excessive volatility won't be tolerated. Market conditioning is, therefore, important.
The judicious use of forex buffers, combined with effective signalling - instead of extreme, or out-of-the-box measures - would be more prudent at this stage. India isn't short on firepower here, with foreign currency assets above $550 bn. RBI needs to reiterate this fact.
Importantly, fundamentals still point in India's favour. By one widely tracked measure - real effective exchange rate - rupee has been undervalued for over a year, the latest print showing an undervaluation of close to 6-7%. That suggests the recent slide may be overshooting reality.
Which brings us back to the core issue: this isn't a story of a weak economy right now. It's a story of fear of unknowns and uncertainty. A more proactive articulation of intent - grounded in India's macroeconomic strengths - can help bridge the gap between perception of what may or may not happen, and reality today.
RBI needs to get ahead of the mood. Because when fundamentals are sound but sentiment is shaky, the most effective policy tool may simply be clarity.
The writer is principal economist, HDFC Bank
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
(Catch all the Business News, Breaking News, and Latest News Updates on The Economic Times.)
Subscribe to The Economic Times Prime and read the ET ePaper online.
...more