Over the last few months, the geopolitical situation and our economic fundamentals have changed. In the aftermath of the West Asia war, crude prices have shot up. India's exchange rate is wobbly, driven by high oil prices and significant sell-off by foreign portfolio investors (FPIs) in equity. All this will affect inflation going forward.
Adding to the concerns, the India Meteorological Department (IMD) has projected monsoon at 90% of the long period average (LPA). If agriculture gets impacted, inflation goes northward. Food is the biggest component of our consumer inflation measurement basket.
Against this backdrop, the monetary policy committee (MPC) of the Reserve Bank of India on Friday decided to hold the repo rate. The repo rate, currently at 5.25%, serves as the anchor for interest rates across the economy. When the RBI raises the repo rate, interest rates generally rise across the financial system. Banks pay more on deposits and charge more on loans.
As per conventional theory, the circumstances described above warrant a rate hike. However, the situation is more nuanced.
Consumer price inflation stood at 3.48% in April 2026, well below the RBI's 4% target. Raising interest rates would neither resolve disruptions in the Strait of Hormuz nor prevent foreign portfolio investors (FPIs) from selling Indian equities. Nor would it influence the monsoon. What it can do is curb demand in the economy and help contain inflationary pressures. But that comes at a cost: slower economic growth. While India's growth is buoyant, we should grow at the maximum potential rate.
The Review
In the policy review, interest rates were kept unchanged at 5.25%; CPI inflation projection for 2026-27 (FY27) was raised significantly from 4.6% earlier to 5.1%, in view of high crude oil prices, rupee's weakness and projection of sub-par monsoon; GDP growth projection for FY27 was trimmed from 6.9% to 6.6%
A major component of expectations for rate hikes in the run-up to the policy review stemmed from a weak exchange rate and the view that higher interest rates could attract dollar inflows.
At around the same time, the government announced a set of measures to support the currency. Investments by FPIs in government securities will be exempt from capital gains tax and withholding tax (TDS).
In addition, the RBI will fully subsidize the forward cover cost for authorised dealers mobilizing FCNR(B) deposits. Public sector enterprises raising funds through external commercial borrowings (ECBs) will also have access to a concessional currency swap window until September 2026.
Collectively, these measures are expected to lead to dollar inflows and help stabilize the rupee.
Prognosis
Taking into account the current situation, the measures announced by the RBI and the government and the overall tone of the policy review, it is clear that we are headed towards policy rate hikes going forward.
The question is: when would the rate hike cycle start? The review on 5 August 2026 would likely be a status quo event. It is likely to start in the October 2026 policy review. By then, we will get clarity on the impact of the monsoon and the West Asia war. The immediate concern was currency weakness, on which measures have been announced.
Market reaction
Market reaction has been largely positive. Post policy announcement, equity indices were flat or marginally higher, bond yields were down and rupee pulled back. Markets liked the fact that interest rates were not hiked and the slew of measures would encourage dollar inflows. The hike in inflation projection and toning down of GDP growth projection were more or less priced in by the markets earlier.
What it means for you
Going forward, borrowing costs are likely to rise. In the banking system, loan offtake is increasing rapidly. Deposits are growing, but at a relatively slower pace. Banks’ margins are under pressure. A future RBI rate hike could provide the final trigger for upward revisions in lending rates, particularly for floating-rate loans.
For savers, however, the outlook is more favourable. Deposit rates are likely to move higher once the rate cycle turns.
For investments, a higher interest rate – or a higher cost of money – is bad for both equity and bond markets. However, the risk appears already priced in. Government support to the rupee would improve FPI sentiments towards India.
Joydeep Sen is a corporate trainer (financial markets) and author