The RBI statement is quite emphatic that the central bank considers inflation as the biggest source of worry. According to the RBI policy statement, the inflation expectations have become very elevated. The sharp rise in inflation in the month of October to 4.6% was largely due to the spike in food inflation. In fact, food inflation at 6.9% was at a 39-month high. The Kharif output had been good but the unseasonal rains in the months of September and October had caused tremendous damage to food crops resulting in a spike in food prices. That was best exhibited by the sharp 7-fold spike in onion prices. The RBI does not see the food inflation coming down any time soon and the status quo on rates was essentially a defence against future rise in food prices. With the OPEC likely to deepen supply cuts, RBI expects the fuel inflation also to spike. That was likely to keep the headline CPI inflation at an elevated level.

Why is inflation important to the RBI? That is because of real rates. In fact, one of the factors that determine the attractiveness of Indian bonds for global investors is the real interest rates (interest yield net of inflation). As of 2018, the real yield was close to 4%. That was an attractive level to entice foreign investors to invest in Indian debt paper. Over the last 1 year, RBI has cut rates by 135 bps and the inflation is up by over 200 bps. This has resulted in the real rates becoming as low as 0.55%. That partially explains why the FPIs had turned net sellers in debt in November 2019. Another rate cut by the RBI would have exposed the real rates to the risk of turning negative, should inflation spike further from current levels. That was one of the key reasons for maintaining status quo on rates.