With the Reserve Bank of India (RBI) raising its inflation forecast for FY27 by a steep 50 basis points (bps) to 5.1%, and with a real possibility that actual inflation could overshoot that estimate, a policy rate hike later this year now appears increasingly likely. The RBI’s projections place inflation at 5.9% in the December quarter, perilously close to the upper end of its 2-6% tolerance band. More importantly, Governor Sanjay Malhotra made it clear that the central bank’s commitment to the 4% inflation target remains unchanged and highlighted the risks from second-round effects, including wage pressures. With petrol and diesel prices already rising, producers and service providers are expected to pass on higher input costs to consumers in the coming months. Reflecting these pressures, core inflation is now projected at 4.7% for FY27, up from 4.4% estimated earlier.
Growth Realities
The implication is that the growth outlook has become considerably more challenging. Elevated energy and commodity prices, coupled with supply shortages, are likely to weigh on economic activity. Some high-frequency indicators are already showing signs of fatigue. A weak monsoon and lower agricultural output could further dampen rural demand, while urban households will see purchasing power eroded by rising prices. Unless supply bottlenecks ease quickly, there are downside risks to the RBI’s revised GDP growth forecast of 6.6% for the current year. Yet, given the dangers of entrenched inflation, price stability will inevitably take precedence over growth concerns. Whether the RBI moves in August or waits until October will depend largely on developments in West Asia and the trajectory of crude oil prices. If oil prices remain elevated and domestic fuel prices continue to rise, markets should prepare for cumulative rate hikes of 50-100 bps over the course of the tightening cycle.
External Account Defence
As closely as markets watched the inflation and growth forecasts, they were equally focused on the RBI’s stance on the rupee, which had weakened nearly 6% between January and early June. Significantly, the central bank has chosen not to use interest rates as a tool to defend the currency. Instead, it has worked with the government to introduce a series of measures aimed at attracting foreign capital. These include swap concessions for external commercial borrowings by state-owned enterprises, hedging relaxations for foreign currency non-resident (bank) deposits, tax relief for foreign investments in government securities, and an expanded universe of eligible bonds. Together, these measures are expected to attract $40-45 billion over the coming months. If realised, such inflows would substantially narrow the estimated balance-of-payments gap of $60-65 billion. Investor confidence in these measures was reflected in the rupee’s sharp appreciation on Friday, when it closed at 94.9450 to the dollar.
The policy review came against the backdrop of a surprisingly strong growth performance in FY26. GDP expanded 7.7%, up from 7.1% in FY25, aided by income-tax and goods and services tax cuts introduced in September 2025. Private final consumption expenditure grew 7.7%, a marked improvement on the previous year’s 5.8%. Gross capital formation also remained robust at 8.2%. Importantly, employment-intensive sectors such as trade, hotels, and transport grew by 11%, compared with a modest 6.6% in FY25. These numbers provide some cushion as the economy navigates a more difficult inflation environment, but sustaining such momentum in the face of higher prices and tighter monetary conditions will be a far greater challenge. After two years of relative macroeconomic stability, India is entering a period where the margin for error is narrower and the variables harder to control.
