Indian Rupee: Inflation and trade reshape INR – Commerzbank

Commerzbank economists have noted that India's August CPI rose to 4.8% year-on-year, surpassing the Reserve Bank of India's (RBI) midpoint but remaining below the central bank's forecast for the year. The economists foresee a more nuanced policy outlook, with a potential hawkish stance at 5.25% at the next meeting on October 7. Meanwhile, a narrower trade deficit and robust capital inflows are expected to bolster the Indian Rupee (INR) despite higher oil prices driving inflation and weakening the currency.

August CPI inflation reached 4.8% year-on-year, slightly above the Bloomberg consensus of 4.9% and surpassing the 4.5% inflation rate observed in July. This marked the highest reading since December 2024 and the third consecutive month above the RBI's 4% midpoint target. Despite the surge in inflation, it has stayed below the RBI's forecast of 5.0% for 2026-2027 and remains within the lower half of its 2-6% target range.

If oil prices remain elevated for an extended period, there is a risk of inflation spiking upward. The policy outlook has become more finely balanced, with the RBI likely to maintain the policy rate at 5.25% at its upcoming meeting on October 7, although it could adopt a hawkish approach. RBI Governor Sanjay Malhotra stated last Friday that underlying price pressures are still low, signaling that a prompt rate hike is not yet necessary.

The August trade deficit narrowed more than anticipated to USD26.9 billion (Bloomberg consensus: USD32.2 billion) compared to USD32.0 billion in July. This narrower deficit is expected to strengthen India's external position, which swung to a USD4.2 billion deficit in Q2 from a USD6.5 billion surplus in Q1. Concurrently, initiatives to lure foreign capital have enhanced the financial account.

In foreign exchange, USD/INR climbed 0.4% to 95.96, just below the psychologically significant 96.00 level. The rupee's weakness was attributed to rising crude oil prices and a stronger US dollar.