RBI holds interest rates as oil shock clouds outlook

The Reserve Bank of India (RBI) on Friday kept its benchmark repo rate unchanged at 5.25%, as expected, and announced a raft of measures to attract foreign capital and support the rupee amid growing risks to growth and inflation from the prolonged West Asia conflict, elevated energy prices and global supply-chain disruptions.

To support the rupee, the measures included scrapping taxes on interest income and capital gains for eligible foreign investors in government securities, offering concessional terms for foreign-currency deposits from non-resident Indians and subsidising hedging costs for select offshore borrowings.

The Monetary Policy Committee (MPC) unanimously voted to leave the policy repo rate unchanged at 5.25%, and continue with its "neutral" stance.

RBI Governor Sanjay Malhotra said India had entered the latest episode of global turbulence with stronger macroeconomic fundamentals than in previous crises, but warned that escalating geopolitical tensions, elevated commodity prices and supply disruptions were clouding the economic outlook.

"The committee noted ​that the global environment has deteriorated," he said announcing the policy decision. The panel felt it would be "prudent" to wait for greater clarity to emerge, he added.

The central bank said underlying inflation pressures remain subdued, but cautioned that rising costs could spill over into wages and inflation expectations. It also cited risks from a below-normal monsoon forecast and possible El Niño conditions, which could put pressure on food prices in the months ahead.

RBI lowered its growth expectations for the current fiscal year, projecting real GDP growth at 6.6% in 2026-27, below the 6.9% April forecast. The projection is also lower than 7.6% estimated for 2025-26.

It forecast inflation to rise to 5.1% in 2026-27, with price pressures expected to peak at 5.9% in the third quarter before easing. This compares to the previous projection of 4.6% average retail inflation for the year.

Core inflation is expected at 4.7%, up from earlier projection of 4.4%.

While headline inflation remains below the RBI's 4% target with a tolerance band of 2-6%, MPC cautioned that higher global energy prices and supply shocks could trigger broader second-round effects on wages and inflation expectations.

"The MPC felt it would be prudent to wait for greater clarity to emerge," the governor said, adding that the central bank would remain data-dependent and closely monitor inflation risks.

The RBI said domestic demand remained resilient, supported by consumption, investment and continued expansion in manufacturing and services.

However, high energy costs, weaker global demand and a forecast of below-normal monsoon rainfall pose risks to growth.

The government said it would scrap taxes on interest income and capital gains for eligible foreign investors in government securities from April 1, 2026, while the RBI broadened the universe of sovereign bonds available under its unrestricted foreign investment route.

The central bank also announced concessional forex swaps for state-run firms raising overseas debt and said it would bear hedging costs on fresh three-to five-year FCNR(B) deposits until September 30 to attract dollar inflows from non-resident Indians.

Together, the measures are aimed at shoring up the rupee which has plunged over 6% this year on war-driven surge in crude prices and record foreign fund outflows.

India's foreign exchange reserves stood at $682.3 billion as of May 29, providing an import cover of about 11 months, the RBI said.

The governor reiterated that the central bank does not target any specific exchange-rate level and would intervene only to curb excessive volatility and prevent disorderly market conditions.

Commenting on the MPC decisions, Upasna Bhardwaj, Chief Economist, Kotak Mahindra Bank said, "RBI expectedly kept the rate and stance unchanged, while highlighting the amplified risks on the inflation front. We expect 50bp of rate hike beginning in October. On the positive side, the measures taken by the RBI to attract capital would help ease pressure on the INR."

Radhika Rao, Senior Economist & Executive Director, DBS Bank said the central bank ticked all boxes to spur dollar inflows and stabilise the currency, signaling that all hands are on deck.

Benchmark rates were held unchanged, but the policy guidance was cautious on inflationary risks from the ongoing West Asia crisis and sub-normal southwest monsoon, she said, "The hawkish pause underscored the central bank's resolve to contain inflationary expectations and defend the currency, while recognising that tighter policy rates have historically only had a limited impact on exchange-rate dynamics."