The rupee has tumbled to record lows since the Iran war broke out at the end of February, as a resultant spike in crude prices delivered a severe blow to Asia’s third-largest economy, which imports nearly 90% of its oil needs.
A hike in the Reserve Bank of India‘s policy repo rate from the current 5.25% on Friday could comfort the currency, but might also rile the rates market, which sees scope for the central bank to stand pat as inflation remains below target.
The RBI is approaching the June meeting with a “dilemma of whether to respond to market pressures or incoming data”, Rahul Bajoria, chief India economist at BofA Global Research said in a note.
“A hold with hawkish guidance would likely be the most elegant compromise, where the RBI does not signal any panic on exchange rate stability, but conveys a willingness to stay vigilant,” Bajoria said.
Nearly 80% of 56 economists in a Reuters poll expect the central bank to keep the repo rate unchanged at 5.25% at the conclusion of its three-day meeting.
Of the remaining respondents, 11 forecast a 25 basis-point hike, while one expected a bigger 50 basis-point increase. The central bank’s key policy rate has been unchanged since December, following 125 basis points of rate cuts last year. Interest rate swaps are pricing in nearly 100 basis points of tightening over the next 12 months, with the one-year OIS rate moving higher by 65 basis points since March. That’s a much more aggressive rerating than in the bond market, where benchmark 10-year yields have risen 37 basis points over the same period.
Rates for Rupee
Although still-benign inflation may offer the central bank wiggle room at the moment, some analysts argue that monetary policy needs to come to the rupee’s defence sooner rather than later.
Rate hikes by oil-importing peers such as Indonesia, the Philippines and Sri Lanka have reinforced bets that the RBI could eventually be forced down a similar path. But India’s central bank does not favour monetary policy action to defend the rupee, Reuters reported earlier.
A preemptive rate hike would probably be the “positive trade-off for the moment”, said Carl Vermassen, a portfolio manager in the emerging markets fixed income team at Zurich-based Vontobel Asset Management.
“You’re already in this situation where you’re a bit stressed with the FX situation, then I would say yes, the normal course of action would be to have a precautionary rate hike,” he said.
Other measures to support India’s beleaguered currency – down 5.4% this year and among Asia’s worst performers – could also be rolled out, Reuters reported earlier.
Revised economic estimates
The central bank is also expected to revise its consumer inflation and growth projections, which it pegged in April at 4.6% and 6.9%, respectively, for the fiscal year to March 2027.
Many economists predict higher inflation and lower growth, with Citi tipping inflation to accelerate towards 4.9% and growth to slow to 6.6%.
That’s due to both higher oil prices and a weaker monsoon, with forecasts for the lowest rainfall in 11 years raising concerns about sharply higher food costs.
Confronted with an unusually high degree of uncertainty and a wide range of possible inflation outcomes, the RBI may have limited scope to deliver a preemptive rate hike, said Citi’s chief India economist, Samiran Chakraborty.
“But the likely above-5% inflation forecast for the second half of fiscal year 2026-27 could be used as a justification to present a more hawkish guidance,” he said.