Global uncertainty still favours earlier interest rate adjustment with steps to ease external pressure
June 1, 2026 00:50 IST
Since the onset of the West Asian crisis in March, consensus has shifted away from the view of a prolonged pause towards a hike by end-March 2027. Economists expect a cumulative 50-75 basis points (bps) of tightening by the end of the financial year, while the market is pricing in close to 100 bps over the same horizon. The main debate now centres on the timing of the first move: June or August?
We have a non-consensus call for a 25-bps hike as early as June. It remains a close call, particularly now that crude oil prices have fallen sharply — down almost 10% in the last week on rising optimism around a peace deal — and the Indian rupee (INR) has retraced part of the heavy losses seen through May 20. Even so, we think there is a case for moving sooner rather than later. We say this for several reasons.
We acknowledge that the April consumer price index (CPI) at 3.5% — below the Monetary Policy Committee’s (MPC) 4% medium-term target — could prove to be a constraining factor. In previous oil-shock episodes — 2013, 2018, and 2022 — the MPC tightened when inflation was already elevated or above their medium-term target of 4%. Central banks also typically lean first on liquidity tools before turning to policy rates, especially when upside inflation risks stem from sharp currency moves. That sequencing has not played out so far.
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However, the sharp INR depreciation against the USD — even after the recent correction — combined with still-weak capital inflows and limited visibility on a turnaround, raises the risk of second-order effects on inflation. According to the Reserve Bank of India’s (RBI) April Monetary Policy Report, a 5% depreciation in the INR relative to the baseline scenario adds 40 bps to headline inflation.
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We expect the MPC’s inflation forecast to be revised up from 4.6% towards 5%. Our expectation is for a FY27 average CPI inflation of 5.2%, assuming crude oil prices ease towards USD 85/barrel by the end of the financial year. If oil prices remain elevated at around USD 100 per barrel and El Niño conditions — now confirmed by the Indian Meteorological Department in its second long-range forecast — adversely affect crop output, inflation could average closer to 5.5%.
Pulses, which have relatively lower irrigation coverage than rice, and vegetables, which are more sensitive to high temperatures and untimely rainfall than other crops, remain the most vulnerable categories. If inflation averages between 5% and 5.5%, with the current repo rate at 5.25%, the implications for market sentiment could be more significant, as real rates would then risk nearing zero or turning negative. With global yields rising, this would add further pressure on the INR and raise the risk of spillovers into inflation. Equally importantly, monetary policy acts with a lag of two-three quarters.
Will a 25-50-bps rate hike be enough to contain the pace of INR depreciation and, by extension, second-order effects on inflation? Not if rate hikes are deployed in isolation. However, if a hike is announced alongside complementary measures that reduce pressure on the external sector, even moderate tightening could go some way towards anchoring sentiment and limiting second-order effects through the INR. The RBI and the government of India have several levers available to support USD inflows.
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These could include a reduction in withholding tax on commercial borrowings, incentives for banks and companies to raise USD through concessions on swap rates, a shorter conversion window for exporters, and a replication of the non-resident Indian deposit scheme of 2013. Measures to contain the import bill — through further retail fuel price hikes and volume restrictions on less productive imports such as gold — could also help.
Can the recent correction in global crude oil prices delay the first hike until August? Yes. However, there remains considerable uncertainty over whether this correction will prove durable. For lower oil prices to be sustained, the peace deal would need to materialise and, more importantly, traffic through the Strait of Hormuz would need to improve meaningfully. There is no clear answer on either front, and experts note that traffic through the Strait of Hormuz, as well as repairing damaged oil production facilities, could take time to normalise even if a peace deal emerges soon.
Even if crude oil prices ease further, they are unlikely to return to the USD 65-67 levels seen before the onset of the West Asian crisis. That would still leave oil prices around 30-40% higher than in FY26. With capital flows already weak, even a pullback from peak oil prices would probably offer only temporary relief to the INR and, by extension, to inflation concerns. If that respite proves short-lived and fades before the August monetary policy meeting, the RBI could find itself in an uncomfortable position between meetings — an outcome that, in our view, policymakers will prefer to avoid.
In a nutshell, while the recent drop in oil prices and partial recovery of the INR lessen the urgency for immediate action, the uncertain global environment in our view still favours an earlier interest rate adjustment with supporting measures to ease external sector pressure. These steps will help India manage a challenging global environment while longer-term efforts are implemented to restore capital flows and make external buffers self-replenishing.
Disclaimer: The views expressed are the author’s own and do not reflect the official policy or position of Financial Express. The author is Head-India, Economics Research, Standard Chartered Bank.
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This article was first uploaded on June one, twenty twenty-six, at fifty minutes past twelve in the am.
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