As the Reserve Bank of India’s (RBI) monetary policy committee’s (MPC) rate review approaches, raising the policy rate is on the table. Underlying inflation pressure has risen with the global energy shock, the rupee has sold off, and capital outflows have been substantial.
Higher rates could support the rupee by raising returns on Indian rupee debt, and by increasing the cost of borrowing in domestic currency, speculative short positions could be discouraged.
The RBI is not alone. The central banks of Indonesia and the Philippines have already begun tightening monetary policy. Nuances, however, matter. Bank Indonesia’s policy mandate explicitly includes rupiah stability that could convince the central bank to tighten policy if the currency faces one-sided depreciation pressure, which has been the case in the past two to three months.
For Bangko Sentral ng Pilipinas (BSP), headline inflation has risen sharply, breaching policy parameters by April-May, with modest domestic support leaving retail fuel prices open to swings in global markets and consequent second-round effects, necessitating a swift, pre-emptive policy response.
In India, policymakers have been concerned about the rupee’s weakness. The monetary policy response might, however, refer to the Tinbergen Principle of “one objective, one instrument”. Targeting multiple objectives carries implicit trade-offs. Therefore, the centrality of the RBI’s price stability mandate is likely to be paramount as the MPC meets to decide on rates, while relying on other instruments to stabilize the currency and bond markets.
Headline inflation based on the Consumer Price Index (CPI) is tracking the midpoint of the 2-6% target range in May, after a below-consensus print in April. Fuel prices have been raised, but the cumulative increase of around 7% is measured.
The MPC is likely to re-emphasize the limited role of monetary policy in countering the first-round impact of a supply shock. In the absence of significant spillovers into core inflation and with inflation expectations still broadly anchored, the central bank might reason that the direct effects are not evident at this juncture, backing a wait-and-watch approach.
On growth, the MPC may point to relatively firm incoming data, while acknowledging downside risks to its fiscal year 2027 (FY27) growth forecast of 6.9% should the conflict become prolonged. We expect the guidance to be cautious, with a pause on rates at this week’s meeting.
The case for hiking rates will be strengthened if the West Asia crisis persists. The inflation rationale will gain momentum amid successive pump price increases (more expected), a pickup in food, impact of prevailing heatwave conditions and rising business inflation expectations (downstream industries), all of which point to mounting underlying price pressures.
If CPI inflation overshoots 5% on-year in FY27, the current repo rate of 5.25% is low, suggesting a 75-100 basis point rate increase in the second half of CY26 is warranted.
A basis point is one-hundredth of a percentage point.
A weak rupee also adds to imported inflationary pressures, with its impact more evident in the wholesale price inflation indices. Since the April rate review, elevated oil prices have triggered a further correction in the rupee asset markets, with the currency depreciating by around 3.2% since April, and a cumulative -6% so far in calender year 2026.
Compared to the revised macro assumption of 94 per dollar in the April monetary policy report, the currency neared a record low of 97 earlier in May before recovering ground on a pullback in oil prices amid ceasefire hopes and speculation about potential fresh measures to support the rupee.
RBI governor Sanjay Malhotra’s observation that the rupee appeared undervalued signalled a notable shift from the traditionally restrained approach toward commenting on currency valuation. The rupee REER (real effective exchange rate) stood at 91.00 in April, near a 12-year low. He also added that the central bank will “do whatever it takes to ensure orderly price discovery in the forex market.”
The central bank has drawn on its reserves to cushion the currency’s weakness. Substantial reserve accumulation in recent years was intended to strengthen buffers for periods of volatility such as the current environment.
The reserves stock scores well across coverage ratios, suggesting there is ample room for the RBI to intervene further.
DBS Bank’s gross external financing ratio (GEFR) suggests that the current stock of reserves is more than adequate versus external obligations. The ratio is at firmer levels versus during the 2013 taper tantrum. Import coverage ratios are off highs but still above the global minimum thresholds. Short-term external debt to reserves ratio has witnessed a notable improvement in the past decade, lending stability to India’s external balances.
Besides intervention, steps announced to date mirror responses undertaken in 2013 (taper tantrum) and 2022 (Russia-Ukraine crisis) and more are likely—concurrent effort to strengthen both sides of the balance of payment equation—current account (through gold/silver curbs and lower energy demand as prices rise) and financing item i.e., capital account (attract inflows, likely other steps to boost non-foreign portfolio investor, or FPI, and foreign direct investment, or FDI, inflows).
A sharp pullback in oil prices will lend relief to the currency the most, but longer-standing issues—reverse the narrowing net FDI position and falling capital account to gross domestic product (GDP) ratio—need to be addressed.
Radhika Rao is executive director and senior economist, DBS Bank. Views are personal.