The Reserve Bank of India maintained its key interest rate unchanged in its first policy decision since the outbreak of the Middle East crisis, as it struggles with a sharply weakening rupee while attempting to support economic growth. Specifically, the six-member Monetary Policy Committee unanimously voted to keep the benchmark repo rate steady at 5.25%, aligning with market expectations, and maintained a "neutral" monetary policy stance. This decision reflects the central bank's wait-and-see approach, as tensions between Iran and the United States are pressuring India's energy supplies and growth outlook. Since the conflict began, the persistent depreciation of the rupee has become the central bank's primary concern, attracting significant attention from the institution in recent days.
Central bank governor Sanjay Malhotra stated that the MPC's neutral stance is intended to preserve the flexibility needed to effectively respond to emerging pressures. Malhotra projected economic growth for the current fiscal year at 6.9%—a more optimistic outlook than that of other economists. Inflation during the same period is expected to be 4.6%, remaining within the central bank's target range of 2%-6%. Approximately half of India's crude oil and most of its cooking gas depend on supplies from the Middle East, making the country particularly vulnerable to any actual closure of the Strait of Hormuz. Over the past year, the rupee has plummeted by about 7%, ranking among the worst-performing currencies in Asia.
Although the Reserve Bank of India has intervened aggressively so far to curb speculative bets against the currency, economists note that a prolonged surge in energy prices could ultimately force the central bank to raise interest rates. To prevent disorderly depreciation of the local currency, the RBI has imposed strict limits on banks' net open positions in onshore rupees, forcing financial institutions to sell dollars on a large scale to stabilize the exchange rate. While this direct intervention has alleviated exchange rate pressures in the short term, it has also caused India's foreign exchange reserves to shrink by approximately $40 billion in just one month, now standing at around $697.1 billion, demonstrating the central bank's firm commitment to defending the rupee's bottom line.
Ahead of the RBI's decision, a ceasefire between the US and Iran boosted market sentiment and triggered a sharp drop in oil prices, leading to the largest decline in Indian sovereign bond yields in four years. Following the decision to keep rates unchanged, yields pared some of their losses. The rupee appreciated by 0.5% against the US dollar, while the Nifty 50 index on the National Stock Exchange of India rose by 3.3% during trading. However, uncertainty regarding inflationary pressures remains a persistent concern, particularly as benchmark crude prices have significantly exceeded the central bank's previously assumed level of $70 per barrel, increasing the risk of energy price transmission to food and manufacturing costs. Additionally, potential disruptions to agricultural production from El Niño could further drive up food inflation.
Radhika Rao, an economist at DBS Group, pointed out that oil prices and inflation risks stemming from geopolitics remain elevated, narrowing the room for near-term monetary easing and reinforcing a prolonged pause. She emphasized that interest rate hikes would only be considered once second-round inflation effects become more apparent. Since February of last year, with inflation consistently well below the 4% target, the RBI has cut rates by a cumulative 125 basis points, including a 25 basis point reduction in December. Consumer price growth has remained subdued so far this year, but a renewed escalation in the Middle East conflict could lead to a rebound, as higher energy import costs feed into inflation. Some economists have also revised down their growth forecasts to reflect India's dependence on oil. Goldman Sachs expects calendar year growth of 5.9%, while Standard Chartered has lowered its forecast for the current fiscal year to 6.4%; both institutions had previously projected growth of around 7% before the outbreak of the Iran conflict.
Comments