The falling rupee poses a new challenge for RBI MPC

The specter of imported inflation through a lower rupee poses a challenge to the Reserve Bank of India’s Monetary Policy Committee, even as many analysts are banking on a February policy rate cut as retail inflation eases.

The rupee fell to a record low of Rs 86.59 against the US dollar earlier this week, and expectations are that it may breach the 87 level by the middle of this year, if not sooner. Officials in New Delhi are understood to be concerned about the impact of the devaluation of the rupee on imports of crude oil as well as a large number of imported items including food items such as pulses and edible oils.

“The rupee depreciation has been positive for exports but will also make imports more expensive,” an official source noted.

Analysts also point out that in theory, core inflation could rise due to the devaluation of the rupee and the recent escalation in global crude oil prices. According to Nomura Bank estimates, each 5% decrease adds about 0.26 percentage points to headline inflation and about 0.1 percentage points to core inflation.

Retail inflation fell in December to a four-month low of 5.22% and food prices saw some marginal decline. The Monetary Policy Committee, headed by new RBI Governor Sanjay Malhotra, is scheduled to meet from February 5-7, and analysts expect a 25 basis point cut in the repo rate on the back of subdued retail inflation and slowing growth to an estimated 6.4% in This fiscal year. .

“The weak currency has exacerbated policy trade-offs. We expect the RBI to follow a more flexible conventional monetary policy framework for targeting inflation. If inflation is close to target despite the weak currency, and growth is below trend, we expect the MPC to support Growth. Hence our call to reduce the repo rate by 25 basis points in February.

However, in a note earlier this month, Standard Chartered said it had postponed its call for a 50 basis point rate cut to April and June from February and April. It also revised its 2025 forecast for the US dollar against the Indian rupee, given increased external sector volatility, evidence of the Reserve Bank of India’s (RBI’s) greater tolerance for a stronger US dollar, and tightening banking system liquidity. “We are revising our USD/INR forecast to 86.25 by March 2025 (84.50), 86.75 by June (85.0), 87.25 (85.25) by September, and 87.75 (85.50) by the end of 2025,” it said.