The macro landscape has changed considerably since the February 2026 rate review. While concern over tariffs was reduced by the US Supreme Court ruling, external risks have increased significantly due to a sharp rise in global oil prices amid geopolitical tensions, which can push inflation above the mid-point of the target range. Financial markets have also shown stress, with rising bond yields and currency depreciation (until the recent administrative restrictions). The RBI’s notification to banks to reduce onshore rupee positions is expected to catalyse short-term INR stability. Reflecting these risks, implied rates have risen sharply as investors factor in the risk of a tighter policy stance.
Starting points matter. Domestic inflation is starting off from a low point, with FY26 average at 2.0-2.2%, suggesting there is more cushion to absorb the risk of fuel price hikes in FY27 (DBSf: 4.6%), without posing material risk to the upper bound of the target range (at 6%). With this shock being primarily supply-driven, monetary policy might be a blunt and potentially ineffective tool in the short term to arrest inflationary expectations. In the context of this stagflationary shock and exogenous nature of the event risk, we expect the RBI to keep rates on hold today, while addressing specific pockets of strain. RBI’s FY27 GDP growth forecast might point to a modest softening in momentum, with April’s Monetary Policy Report to carry updated economic assumptions (Oct25 had oil at $70pb and INR at 88.00). A shift towards a tighter policy stance will hinge on significant spillover risks to core inflation, fuel price hikes, and potential second-round effects. In essence, the policy outlook will shift from a “benign inflation–strong growth” scenario to a more “cautious balancing act”, where the central bank will respond to renewed inflationary pressures while sustaining growth.
On INR, unwinding of the onshore leg following regulatory changes (see here and here) has led to a reprieve in the spot, with USDINR trading near the 93.0 handle from near 95.0 before. Subsequently, hedging costs for foreign investors have broadly risen, which alongside disruption in onshore and NDF price discovery, along with volatility in FX swap implied yields, could cap fresh interest in INR assets. Beyond the near-term relief for the INR, any signs of fresh bearish pressure on the currency might necessitate further action if the US-Iran war were to be prolonged. Market chatter suggests that the central bank could reintroduce FCNR B like structure to attract non-resident inflows, akin to 2013. The underlying concessional swap rate and window had improved the attractiveness of the facility back then. Other notable options from the 2013 playbook include – special oil window to channelise dollar demand, gold import curbs, concessions for debt investors, and policy tightening attract rate sensitive flows, etc.
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