The season’s first RBI monetary policy began with a status quo. On Wednesday, the six-member Monetary Policy Committee (MPC) kept rates unchanged, as widely expected, but sounded cautious about what lies ahead.
The benchmark repo rate stands at 5.25%, while the Standing Deposit Facility, Marginal Standing Facility, and Bank Rate are held at 5%, 5.5%, and 5.5%, respectively. The MPC also unanimously decided to retain a neutral stance, allowing itself room to respond with rate cuts or hikes depending on evolving global market conditions.
A surprise two-week ceasefire comes as the Iran war enters its sixth week. While this development lifted the Sensex and Nifty by nearly 4%, it remains unclear whether the global economy has merely weathered a shock or is heading into a deeper crisis.
For now, volatile crude oil prices and speculation have disrupted everything from growth forecasts to inflation estimates worldwide.
Importantly, back home, markets had expected at least two more rate cuts this fiscal. However, not only have these expectations been scrapped, but anticipation has now shifted toward possible rate hikes. In fact, monetary policymakers globally are sending hawkish signals, focusing on second-round inflation effects rather than the initial shock. For instance, the European Central Bank is expected to raise rates two to three times in 2026, the Bank of England twice, while analysts have entirely ruled out Federal Reserve rate cuts.
Often, higher prices and growth slowdowns become evident only in hindsight. This time, however, the RBI has provided early warning, with Governor Sanjay Malhotra confirming that the first two quarters of the current fiscal will be impacted. Real GDP growth is expected to slow from FY26’s projected 7.6% (under the new GDP series) to 6.9% in FY27.
Similarly, inflation is projected to rise to 4.6% in FY27, compared to 2.1% in FY26. For the first time, the RBI has provided full-year forecasts for core inflation, pegged at 4.4%.
Quarterly growth is expected at 6.8% in Q1, 6.7% in Q2, 7% in Q3, and 7.2% in Q4. However, as Malhotra cautioned, much depends on the intensity and duration of the ongoing conflict in the Middle East. That said, India’s growth fundamentals are stronger than before, and the economy remains resilient enough to withstand shocks. Nevertheless, the RBI will remain prudent in taking timely policy actions.
On inflation, Q1 is pegged at 4%, Q2 at 4.4%, Q3 at 5.2%, and Q4 at 4.7%.
Encouragingly, the expected rise in prices comes off a low base, with FY26 inflation averaging around 2–2.2%. This provides some cushion to absorb potential fuel price hikes this fiscal. However, a prolonged increase in energy prices could pose significant risks to the 6% upper inflation target. Worse, if energy price and supply shocks persist, the drag on growth could outweigh the inflation impact. This is unfortunate.
As recently as December, Malhotra had expressed optimism, citing India’s “Goldilocks phase” of strong growth and low inflation, which allowed the RBI to maintain a loose policy stance for an extended period. That luxury no longer exists. If the current energy shock persists, the combination of weaker growth and rising inflation will push the MPC into a difficult position—choosing between supporting growth and controlling inflation.
Moreover, the RBI’s pivot from rate cuts to potential hikes depends on an unpredictable variable: the duration of the Iran conflict, structural damage to critical infrastructure, and the reopening of the Strait of Hormuz. As economists note, short-lived energy price spikes may be manageable, but prolonged disruptions could weaken the economy significantly, raising the specter of stagflation—stagnant growth combined with high inflation.
Such a scenario presents a serious dilemma for the RBI: raise rates to curb inflation and risk triggering a recession, or allow inflation to rise and risk a self-reinforcing spiral that becomes difficult to control. A rate hike in the face of an oil price shock could be particularly damaging.
As Malhotra explained, elevated oil prices lead to imported inflation and widen India’s current account deficit (CAD). Private estimates peg the CAD at -1.8% of GDP, compared to a baseline of -1.3%. A higher CAD, combined with subdued capital flows, could result in a third consecutive balance of payments deficit—a first for the economy, according to DBS. This would further increase the vulnerability of the rupee to near-term weakness.
