A new report suggests that persistent high crude oil prices could force the Reserve Bank of India (RBI) to raise interest rates to combat rising inflation, potentially impacting the Indian economy.
Illustration: Dado Ruvic/Reuters
Key Points
- Sustained crude oil prices above $100 per barrel could push India’s headline inflation above 6 per cent, triggering potential RBI rate hikes.
- The report suggests risks associated with using interest rates to defend the Indian Rupee (INR) amid rising oil prices.
- Economists recommend a ‘neutral’ stance on both monetary and fiscal fronts, avoiding premature demand stimulation to prevent stoking inflation.
- Maintaining the fiscal deficit close to FY26 levels and raising petrol and diesel prices are suggested to contain the fiscal deficit.
- The flexible inflation targeting framework allows inflation to stay within the 2-6 per cent range, but prolonged energy shock could impact growth.
Crude oil sustaining above $100 per barrel will push the headline inflation above 6 per cent, the upper level of RBI’s tolerance band, and trigger rate hikes, a foreign brokerage has said.
Economists at HSBC said that consumer price inflation (CPI) will remain below 6 per cent if oil prices average below $100 per barrel, as per its modelling.
“… Sustained oil above USD100/bbl would push inflation beyond 6 per cent, likely triggering rate hikes,” the economists said, adding that we are at “crossroads” as Brent has averaged $100 in March.
Amid speculation ahead of next Wednesday’s monetary policy announcement on whether the RBI uses interest rates to defend the rupee, the report suggested risks of such a move.
“An interest-rate defence for the INR can be expensive when the growth drag becomes non-linear and intensifies quickly with higher oil prices,” it said.
Recommendations for a Neutral Stance
The economists recommended adopting a “neutral” stance on both the monetary and fiscal fronts for now, as the supplies are yet to be cleared and stimulating demand can stoke inflation.
Pointing out that doing so would be akin to the experience during the COVID pandemic, the report said stimulating demand before supply was repaired led to high and sticky inflation back then.
“The lesson now is clear: avoid boosting demand too early. But this is a delicate balance. Policymakers don’t want to overstimulate, but they also can’t tighten so much that the growth slowdown deepens,” it added.
Elaborating on the “neutral” prescription, it said this would mean keeping the fiscal deficit close to FY26 levels and raising petrol and diesel prices to help contain the fiscal deficit.
On the monetary side, the “flexible” inflation targeting framework allows inflation to stay within the 2-6 per cent range, it added.
If the ongoing energy shock persists for a few more weeks, the growth drag could begin to outweigh the inflation shock, it said.
