Inflation: Is RBI Looking At Yesterday Rather Than Tomorrow?

But central banking is not about reacting to yesterday’s inflation, but preventing tomorrow's.

That is where the latest monetary policy leaves room for debate. The RBI's assessment appears anchored almost entirely on past and current CPI readings, even as several leading indicators suggest that inflation risks are steadily building beneath the surface. Persistently high wholesale inflation, resilient domestic demand, relatively stronger credit growth, volatile global commodity markets, and the growing threat of an El Niño-induced supply shock paint a picture that is considerably less benign than the headline inflation number suggests.

The RBI itself expects CPI inflation to rise from 4.4% in June to 5.9% in the third quarter before easing later in the year. It also acknowledges that food and fuel prices remain vulnerable to geopolitical developments and deficient rainfall, and explicitly warns of possible second-round effects.

Yet these concerns ultimately did not translate into either a change in rates or even a shift towards a more cautious policy guidance. One wonders why. The minutes of the meeting, when they are released, perhaps will reveal the reasoning. 

The central bank places overwhelming emphasis on CPI because that is its formal inflation target. Core inflation, excluding food and fuel, remains at 3.9%, while core inflation, excluding precious metals, is even lower. Since demand-side inflation remained muted, the RBI concluded there was little reason to tighten monetary policy. That framework has no doubt served India well over the past decade. But inflation targeting is surely about guiding inflationary expectations, not lagging behind them.

WPI Inflation Climbed Close To Double Digits

Wholesale prices are telling a very different story. WPI inflation has remained above 8% since April 2026 and climbed close to double digits in June. Wholesale and consumer price inflation do not move in lockstep. Therefore, monetary policy should not react mechanically to consumer prices. Firms often initially absorb rising input costs through lower margins, preventing immediate pass-through to consumers. But businesses cannot absorb rising costs indefinitely. Smart monetary policy anticipates the rising trend.

The RBI itself notes that higher input costs have so far resulted in only "limited pass-through" into consumer prices. The key words are "so far". If wholesale inflation remains elevated for several months, firms will eventually pass those costs downstream. Producer price inflation is often an early warning rather than a coincidence. Ignoring it because CPI remains contained risks waiting until inflationary expectations have already become embedded. That can often be too late. 

The second reason for adopting a less expansive and accommodative stance is that the economy no longer needs exceptionally supportive monetary conditions. The RBI's own assessment about economic growth is strikingly optimistic. According to its own press release, manufacturing continues to expand. Services remain buoyant. Merchandise exports have rebounded. Investment is supported by strong infrastructure spending and capacity utilisation. Bank credit is growing at over 17% year-on-year, a marked increase over previous quarters. Reflecting this resilience, the RBI has revised its growth forecast for 2026-27 marginally upwards to 6.7%.

Strong growth prospects should also influence a forward-looking monetary policy as much as current inflationary conditions do. 

When growth is weak, central banks rightly look through temporary supply shocks. But when domestic demand is healthy, credit is expanding reasonably, and the economy is operating smoothly, the argument for maintaining a neutral stance becomes less compelling. The economy today is far better placed to absorb modest monetary tightening than it was during the post-pandemic recovery.

El Niño Factor

The weather outlook strengthens that argument further. The RBI repeatedly identifies El Niño as one of the biggest risks facing the economy. Deficient and uneven monsoon rainfall threatens agricultural output, while volatile global energy markets continue to cloud the inflation outlook. The government may possess comfortable foodgrain stocks and can intervene through supply-side measures, but history suggests that weather-driven food inflation is rarely contained without spillovers.

Food inflation does not stay confined to vegetables and cereals. It influences wages, transport costs, restaurant prices, and household inflationary expectations. Once these second-round effects take hold, inflation becomes significantly more difficult to reverse. This is why monetary policy must remain forward-looking.

The RBI's own statement recognises nearly every inflation risk that economists are currently worried about. It cites geopolitical uncertainty, volatile crude oil prices, El Niño, supply-chain disruptions, and the possibility of broader inflationary pressures. It also notes that several central banks around the world have either tightened policy further or remain firmly focused on inflation.

The Case For A Forward-Looking Monetary Policy

None of this necessarily warrants an immediate rate hike. Monetary policy should not overreact to temporary supply shocks, particularly when core inflation remains contained. But there is a meaningful difference between holding rates unchanged and signalling that inflation risks remain evenly balanced. 

Today's macroeconomic environment no longer looks evenly balanced.

Growth has surprised on the upside. Wholesale prices continue to accelerate. Credit growth remains robust. Weather-related risks are increasing rather than fading. The inflation outlook is becoming less benign.

Under these conditions, the RBI did not need to raise interest rates this week. But it did need to acknowledge more clearly that the next policy move is more likely to be towards tighter monetary conditions than easier ones. Monetary policy works best when it stays ahead of inflation, not when it waits for inflation to catch up.

(Rajiv Kumar is an eminent economist and Chairperson, Pahlé India Foundation. Samriddhi Prakash is a Research Associate at Pahlé India Foundation. Views expressed are personal.)