RBI May Impose 25-50 Bp Rate Hike in FY27 Amid Persistent Energy-Driven Inflation

RBI's Policy Backdrop Becomes Increasingly Challenging Amidst West Asia Conflict

The Reserve Bank of India's (RBI) policy backdrop has become increasingly challenging as surging crude oil prices drive inflation risks upwards. As the West Asia conflict continues to escalate, the RBI may stay on hold in the near term, but if energy-led inflation persists and broadens, 25–50 bps of rate hikes in FY27 are likely.

Impact of West Asia Conflict on Indian Economy

The conflict in West Asia has had a significant impact on the Indian economy, with Indian benchmark indices falling around 11.5 percent in March. Record FII outflows of Rs 1.2 lakh crore were seen, while DIIs continued to be net buyers to the tune of Rs 1.3 lakh crore. Volatility spiked, bond yields hardened, and the rupee continued to slide during the month as inflation expectations and widening CAD risks surfaced with oil at elevated levels.

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Impact on Earnings and Capex Decisions

The impact of the conflict on earnings and capex decisions is expected to be significant. Himanshu Kohli, Co-founder of Client Associates, expects managements across the board to be more cautious in their commentaries given the recent developments in the West Asia. Capex decisions are likely to get delayed given the uncertainty, and the future guidance of impacted sectors is likely to get trimmed to some extent.

Defence Sector: A Bright Spot Amidst Uncertainty

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Despite recent corrections, Himanshu believes the valuations are still elevated for the defence sector; however, the fundamental trajectory appears robust. The sector is transitioning from import-dependency to indigenisation and design-led manufacturing, and global military spending has accelerated in recent years. India's FY27 defence budget has also increased by 15 percent to Rs 7.8 lakh crore, collectively reinforcing a capex cycle across air, naval, and advanced defence systems.

RBI's Policy Response

The RBI is likely to keep using regulatory tightening and market intervention to control volatility, and may also continue supporting the bond market through OMOs or other liquidity measures as needed. To offset the liquidity drain from such forex operations, it may also continue to stay on hold in the near term. However, if energy-led inflation persists and broadens, 25–50 bps of rate hikes in FY27 are likely.

Key Buying Opportunities

The current scenario brings us back to the fundamentals of investing. Asset Allocation and diversification remain the cornerstone of investing for tiding through volatile times. Buying on dips remains an opportune strategy. We prefer opportunities in well-researched market cap and sector-agnostic actively managed products with strong focus on risk management. In terms of sectoral allocations, we prefer structural opportunities like Financials, Consumer Discretionary, and Defence plays.