Interest Rate Hike Decision on Hold: Central Bank Likely to Maintain Current Stance

India's Macroeconomic Outlook Clouded by West Asia Crisis

The global environment has undergone a significant transformation over the last six weeks, with geopolitical tensions in West Asia leading to a near doubling of global energy prices, increased market volatility, depreciation pressure in the INR, and a surge in G-sec yields. This development is likely to have a substantial impact on India's macroeconomic outcomes for FY2027, with the extent of the effect depending on the duration of the crisis.

Domestically, the National Statistics Office (NSO) switched to the new CPI series (base year: 2024) from mid-February 2026, with year-on-year (YoY) CPI inflation pegged at 2.7% in January 2026 and 3.2% in February 2026. The uptick in February 2026 was largely driven by the food and beverages (F&B) segment, while the core CPI (CPI excluding F&B and electricity, gas, and other fuels) inflation remained unchanged at 3.4% in these months. A stricter measure of core inflation, which also excludes auto fuels and jewellery, printed at a muted 2.1% in both these months, suggesting that underlying demand pressures were subdued prior to the onset of the West Asia crisis.

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ICRA expects the headline CPI inflation to inch up to ~3.3% in March 2026, taking the average for Q4 FY2026 to 3.1%. Thereafter, the reading is expected to cross the 4.0%-mark in Q1 FY2027, averaging at 4.3% in the fiscal in our base case, assuming that global crude oil prices average at $85/barrel during the year and there is no pass through to retail selling prices (RSP) of auto fuels. However, higher average oil prices would pose material upside risks to our estimates.

In response to the crude price shock, the Government of India (GoI) reduced the special additional excise duty (SAED) on petrol and diesel by Rs. 10/litre each from March 27, 2026. This is expected to partly offset the under-recoveries of the Oil Marketing Companies (OMC), while keeping the retail prices unchanged. Even after this, OMCs would incur a loss of Rs. 2/litre on petrol and Rs. 8/litre on diesel, with crude oil at $105/bbl. With limited headroom to cut excise duties further, the GoI would need to raise fuel prices if the conflict persists or if crude oil prices do not cool in the near term.

On the growth front, as per the data for the new GDP series (base year 2022-23) released at end-February 2026, India's GDP growth eased to 7.8% in Q3 FY2026 from 8.4% in Q2 FY2026, led by the agricultural and industrial sectors, partly on account of an adverse base. Thereafter, while trends in high-frequency indicators for January-February 2026 appear favourable, the adverse impact of the West Asia crisis is likely to play out in March 2026, which is likely to pull down the growth to ~7.0% in Q4 FY2026.

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Looking ahead, heightened uncertainty around the duration of the West Asia conflict casts a shadow on the near-term macroeconomic outlook amid high import dependency for items such as natural gas and fertilisers, in addition to crude oil. If the conflict lasts for an extended period, the adverse implications of the same could widen across sectors, amid an uptick in input costs, consequently impacting the profitability of India Inc. Not just price, but the availability of inputs will also have a critical bearing on India's macro outcomes in FY2027.

At an average crude oil price of $85/bbl, India's GDP growth is expected to moderate to 6.5% in FY2027 from the projected 7.5% in FY2026. The extent of the downside to our forecast would be contingent on the duration of the conflict and consequent implications on energy prices and availability, domestic investment, inflation, and external trade.

High energy prices will adversely impact the GoI's fiscal math in FY2027, led by rising fertiliser and fuel subsidy requirements, lower dividend pay-out by OMCs, and lower excise duty and corporate tax collections, notwithstanding some buffer on account of the Economic Stabilisation Fund (ESF). This could lead to an overshooting in the fiscal deficit target, along with a paring of discretionary spending, including capex, vis-à-vis the budgeted levels, which is likely to have an adverse impact on growth outcomes. Such fears have led to an upward spiral in G-sec yields, with the same for the 10-year security crossing the 7.1% mark in April 2026 from 6.7% at end-February 2026.

Besides, the current account deficit (CAD) is estimated at 1.7% of GDP in FY2027, with sizeable upside risks, amid every $10 increase in the average price of crude oil for the year (vis-à-vis the baseline estimate) pushing up the same by ~30-40 bps. This is expected to lead to a sizeable drawdown of reserves, amid shrinking net capital inflows, while exerting downward pressure on the USD/INR pair.

Overall, while heightened uncertainty clouds growth and inflation estimates, the MPC may choose to provide ranges of estimates for FY2027. It will also have to contend with rising yields and a downward pressure on the currency when it announces its decision later this week.

We expect the Committee to maintain status quo on the policy rates as well as stance, while striking a cautious, data and development-based tone in the policy document. Nevertheless, we expect the RBI to highlight continued liquidity support, which could prevent bond yields from rising incessantly.

Aditi Nayar is Chief Economist, Head- Research & Outreach, ICRA. Views are personal, and do not represent the stand of this publication.