RBI holds rates at 5.25% as oil surge clouds inflation outlook

India's central bank held rates steady on Friday but raised its inflation forecast, signaling a growing risk of a hike in August.

The Reserve Bank of India kept its benchmark repurchase rate at 5.25% on Friday, opting to wait for greater clarity on inflation as a war-driven surge in crude prices pushed the rupee to historic lows.

"Given the global environment has deteriorated, it is prudent to wait until greater clarity emerges," Governor Sanjay Malhotra said in announcing the decision. The six-member monetary policy committee voted unanimously to hold, maintaining a "neutral" stance.

The central bank raised its average retail inflation forecast for the current fiscal year to 5.1% from 4.6%, while cutting its GDP growth projection to 6.6% from 6.9%. India's benchmark 10-year bond yield edged lower to 6.96% following the decision, while the rupee weakened slightly to 96.72 against the dollar. The Nifty 50 added 0.2% in early trading.

The decision comes as Brent crude trades 33% higher since the U.S.-Israeli war on Iran began in late February, inflating India's import bill and fueling inflation in the world's third-largest crude importer. Foreign investors have pulled a record $28.2 billion from Indian stocks this year, while the rupee has slid nearly 5% to historic lows.

The RBI's updated projections reflect the deteriorating outlook. Average retail inflation is now seen at 5.1% for the year, up from the 4.6% forecast in April, though still within the central bank's 2% to 6% tolerance band. Core inflation is projected at 4.7%, compared with 4.4% previously. On growth, the central bank now expects the economy to expand 6.6%, below the 6.9% it forecast two months ago and down from an estimated 7.6% in the year ended March 31.

The global backdrop has shifted markedly since the RBI's last meeting. Brent crude has surged 33% since the conflict erupted, raising India's import costs and threatening to slow consumption among the country's vast middle class. The government is weighing spending cuts across parts of the budget as higher oil prices inflate subsidy bills and jeopardize fiscal consolidation targets.

Rate-Hike Bets Build

Across emerging Asia, central banks are already moving to defend their currencies. Indonesia, the Philippines and Sri Lanka have raised interest rates in recent weeks, while South Korea has signaled a turn is imminent. "The surprise rate hikes in EM economies have raised hopes among a section of the market for rate hikes to defend the rupee," said Hitesh Suvarna, macro economist at JM Financial Institutional Securities. "However, considering inflation will not decisively breach the 6% mark, it will not compel the RBI to hike policy rates."

Markets are pricing a growing probability of a rate increase at the RBI's next meeting in August. The central bank's updated forecasts — higher inflation, lower growth — leave it with a narrowing window to act before price pressures become entrenched. If oil prices remain elevated, the case for a hike will strengthen considerably by the time policymakers meet again in two months.

This article is for informational purposes only and does not constitute investment advice.