While keeping the repo rate unchanged at 5.25 percent and retaining a neutral policy stance, the RBI on Friday raised its inflation forecast for 2026-27 to 5.1 percent and revised the real GDP estimate down to 6.6 percent. An anticipated slowdown is writ large on the more-than-a-percentage-point cut from 2025-26’s revised growth rate of 7.7 percent. Given the Gulf war’s continuing uncertainties, growth may suffer even further. With fuel prices rising by ₹7.5 a litre last month, inflation prints from May onwards will likely breach 4 percent. Wholesale inflation hit 8.3 percent in April, and the pass-through of input cost pressures to the consumer basket is inevitable. What is more worrisome is that the RBI expects inflation in the second, third and fourth quarters to top 5 percent—which means higher prices will persist throughout 2026-27. The projections assume the Indian crude oil import basket at $95 a barrel; but if energy shortages deepen, headline inflation runs the risk of breaching the upper ‘tolerance limit’ of 6 percent.
For now, Governor Sanjay Malhotra is willing to look past fuel inflation and act only when the price rise broadens. In any case, tightening rates now will lower neither the headline inflation nor pump prices. That said, Malhotra may be forced to raise rates to contain the second-round effects, as inflation expectations are harder to control than inflation itself. Seen in this context, Friday’s decisions were less about growth-inflation dynamics and more to do with external problems. First up was rupee depreciation. Instead of deploying rate hikes to defend the currency, the RBI turned to foreign investors by fully opening up access to the Indian bond market to include papers beyond 10-year tenors.
Further sweetening the deal, the government offered tax exemptions on interest and capital gains on bond sales. However, it’s unclear if Friday’s bonanza can stem the sustained flight of foreign capital. Foreign investors are dumping Indian equities in truckloads, but not bonds. In fact, their bond holdings are smaller than of equities. But together with the RBI’s other measures allowing banks to raise deposits from Indians abroad and making it easier for public sector companies to raise external commercial borrowings, India expects to attract $35-45 billion in foreign capital—just enough to bridge the anticipated balance of payments shortfall for 2026-27.