RBI Interest Rate Hike Looms as Monetary Policy Cycle Nears Turning Point in FY27

Global Energy Crisis Shifts Monetary Policy Expectations

The global environment has undergone a significant shift since the February monetary policy review, driven by intensifying geopolitical tensions in West Asia. The energy complex has experienced a sharp surge, with clear implications for costs and inflation.

The current situation differs from past West Asian episodes primarily because an essential chokepoint for global energy flows, the Strait of Hormuz, is physically disrupted. The duration of the closure and extent of infrastructure impairment will determine the persistence of the shock. A quick resolution would limit global spillovers, with only mild slowing in global GDP. However, if the blockage extends beyond a quarter, crude prices will need to rise enough to induce significant global demand destruction.

These risks have shifted global monetary expectations, with hopes of policy easing fading and some markets tentatively pricing rate hikes. The US Federal Reserve is now expected to remain on hold until June 2027, versus expectations of 75 bps of cuts earlier. In India, markets are pricing three rate hikes over the next six months.

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Financial year 2026 delivered an exceptionally favorable disinflation outcome for the RBI, but FY27 was always expected to mark the beginning of inflation normalization. Inflation has clearly bottomed out and is now turning up. An unfavorable food base and El Niño-linked weather risks had already raised the likelihood of higher food inflation, and the latest surge in global energy prices has amplified these pressures.

A meaningful escalation in the Russia-Ukraine conflict began on 22 February 2022, triggering an immediate surge in global energy prices. A defining feature of the 2022 episode was its impact on global food markets. Wheat futures spiked from about US$ 670/bushel in January 2022 to US$ 1,100–1,200/bushel within just two months.

In India, retail petrol and diesel prices increased by ₹10/litre between March and April 2022, although the rise was offset by an excise duty reduction in late May. CPI inflation was already near 6% in Jan-Feb 2022, while the policy rate stood at 4%, implying a negative real rate of around 2%.

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The RBI responded through an unscheduled policy meeting in early May 2022, raising the repo rate by 40 bps, followed by 50 bps in June. Between May 2022 and February 2023, the repo rate rose from 4% to 6.50%. Every period since 2000 during which crude remained above US$ 80/bbl for a sustained duration has coincided with an Indian rate-hiking cycle.

2026 vs. 2022

Despite rising global risks, we expect the RBI to remain on hold in April and maintain a neutral stance, while highlighting both growth and inflation uncertainties. The current starting point offers some buffer. With the repo rate at 5.25% and CPI inflation at 3.75% (February 2026), real rates are a positive 1.50 percentage points. WPI inflation could climb from around 2% to double digits in the coming months.

However, the immediate inflation passthrough is being partly absorbed by industry and the government. Retail fuel prices remain stable as OMCs absorb losses, and the Central Government has implemented an excise duty cut of ₹10/litre (a monthly revenue loss of ₹140 billion). Meanwhile, global food prices remain subdued for now.

Nonetheless, in India, food inflation presents a substantial risk due to an unfavorable base and potential weather disruptions during the Kharif season. We expect food inflation to rise from around 0% in FY26 to about 7% in FY27.

Core inflation may also drift higher. Many producers of household goods and service providers may be forced to pass on higher input costs. More importantly, emerging constraints on energy availability are already leading to supply-side disruptions. In such periods, firms commonly implement staggered price increases to recoup their revenue losses, creating broader inflationary spillovers beyond sectors directly hit by energy prices.

India's Balance of Payments

India's balance of payments has deteriorated due to negligible net FDI inflows. Dollar borrowing remains unattractive for corporates, and despite structural improvements in the current account, the capital account deficit (negative for the first time since FY74) is weighing on the rupee.

Spot FX reserves stand at US$ 717 billion (as of 6 March 2026), but forward liabilities of US$ 68 billion (January 2026) and an estimated additional US$ 20–25 billion by March reduce effective reserves meaningfully. If FII inflows fail to revive, which appears likely as long as global energy disruptions persist, the rupee will remain vulnerable to global shocks.

The excise duty cut on fuel implies an annual revenue loss of ₹1.7 trillion (0.4% of GDP), nearly half of the Centre's excise collections. Fertiliser subsidies could also rise sharply, as seen in FY23 when they were revised from ₹1.5 trillion to ₹2.5 trillion. The Economic Stabilization Fund's ₹1 trillion corpus provides partial relief, yet fiscal risks are clearly rising.

A large BoP deficit of US$ 40–45 billion (₹3.5–4 trillion) in FY27 strengthens the case for RBI OMO purchases to maintain liquidity at current surplus levels. Currency leakage of ₹2.5–3 trillion and an organic CRR-related drain of about ₹1.3 trillion could withdraw up to ₹4 trillion of liquidity. While the RBI's budgeted dividend of ₹2.8 trillion will inject liquidity, a ₹3.5 trillion BoP deficit implies the need for ₹4.5–5 trillion of OMOs to maintain conditions near current levels.

Though OMOs provide support to government bonds, rising risks of fiscal slippage, elevated inflation, a weaker rupee, simultaneous rise in both private and government credit, and deteriorating G-sec valuations all argue for an upward bias in the term structure of rates in FY27, even if the policy rate hikes remain moderate.

Views are personal and do not represent the stand of this publication.