Stability at the Edge of Turbulence

Amid war-driven oil shocks and a weakening rupee, the RBI opts for caution and reform.

India delivered a strong performance in 2025, with growth estimated at 7.6 percent and inflation contained at 1.95 percent, setting the stage for continued momentum into 2026. Benefiting from a ‘Goldilocks’ mix of robust growth and subdued inflation, the government presented a budget focused on long-term stability rather than short-term stimulus. Following last year’s front-loaded rate cut, the RBI was closely monitoring its impact and managing conditions with confidence.

By late February, however, the US–Iran conflict disrupted this trajectory, exposing vulnerabilities India had largely contained until then. With the situation evolving rapidly, even minor developments risked altering the assumptions behind the decisions taken by the Monetary Policy Committee (MPC). The RBI Governor’s scheduled April 8 address came amid this uncertainty, though a temporary pause in hostilities offered some relief until the committee’s stance was formally communicated.

Fiscal Derangement

The US–Iran conflict triggered a global energy and logistics crisis, pushing crude oil above $100 per barrel and straining India’s current account and fiscal stability while raising inflation risks. With 85–90 percent of oil imported, the RBI’s baseline assumed $85 per barrel, but internal models showed every 10 percent increase could add 50 basis points to inflation and shave 15 basis points off growth. To cushion the shock, the government cut excise duties on petrol and diesel, allowing oil marketing companies to absorb costs and avert an immediate inflation spike. Meanwhile, the rupee depreciated 11 percent over the year, sliding past 95 per US dollar.

Despite these pressures, India’s $696.1 billion forex reserves and strong banking fundamentals provided crucial buffers, shaping the MPC’s deliberations into a cautious balancing act between external volatility and domestic resilience.

The MPC meeting ended with a unanimous decision to keep all major policy rates unchanged. The policy repo rate was held steady at 5.25 percent, the Standing Deposit Facility at 5.00 percent, the Marginal Standing Facility and Bank Rate at 5.50 percent, while the overall stance remained neutral. The neutral stance signals that the RBI is neither in a tightening nor easing cycle but has preserved the flexibility to respond to shifting geopolitical and inflationary pressures. By maintaining a stable repo rate environment, the RBI has provided predictability for borrowing costs, which is crucial for the domestic lending ecosystem.

Beyond interest rate decisions, the RBI unveiled structural reforms to reinforce governance and efficiency in the financial system. Bank boards will now focus more on strategy and risk oversight, while regulatory simplification has consolidated over 9,000 instructions into 238 Master Directions with streamlined supervisory guidelines. MSMEs will gain faster credit access through the removal of due diligence requirements for TReDS onboarding, and a new framework for categorizing NBFCs into middle and upper layers ensures proportionate oversight for systemically important institutions. Together, these measures reflect the RBI’s calibrated approach of maintaining stability amid uncertainty while advancing reforms to strengthen the resilience of India’s financial system.

Cautious Recalibration

The RBI’s growth outlook for FY 2026–27 reflects a cautious recalibration in light of the US–Iran conflict. While growth in FY 2025–26 was estimated at a robust 7.6 percent, projections for FY 2026–27 have been moderated to 6.9 percent, signalling the impact of supply-side shocks and global uncertainty. The quarterly trajectory suggests slower growth in the first half of the year, with Q1 and Q2 expected at 6.8 percent and 6.7 percent respectively, before a recovery in Q3 and Q4 to 7.0 percent and 7.2 percent.

Governor Malhotra observed that while India’s domestic fundamentals were strong before the conflict, conditions worsened as the crisis escalated in March. The slowdown was driven by rising input costs from higher energy and commodity prices, logistical bottlenecks caused by disruptions in the Strait of Hormuz, weaker external demand amid slowing global growth, and investment delays as corporates adopted a cautious stance.

Despite these challenges, the RBI expects growth to regain momentum in the second half of FY27. This recovery is likely to be supported by the continued strength of the services sector, the benefits of GST rationalization, and the resilience of financial institutions with solid balance sheets that ensure steady credit flow. The government’s push to expand domestic manufacturing in strategic sectors is also seen as a durable driver of growth, reinforcing confidence that India’s medium-term trajectory remains intact even against geopolitical turbulence.

The RBI’s inflation outlook for FY 2026–27 reflects the new reality of elevated oil prices and disrupted supply chains. Headline CPI inflation is now projected at 4.6 percent, slightly higher than earlier estimates of 4.5 percent. The quarterly trajectory shows inflation remaining contained in the first half of the year, with 4.0 percent in Q1 and 4.4 percent in Q2, before peaking at 5.2 percent in Q3 as second-round effects of the energy shock feed into broader prices. A moderation to 4.7 percent is expected in Q4, keeping inflation within the 2–6 percent tolerance band.

Governor Malhotra emphasized that inflation targeting remains anchored to the 4 percent goal, but the focus has shifted to understanding the sources of inflation and preventing spillovers into core components. In this context, the RBI is “looking through” the immediate supply shock while remaining vigilant against its persistence. The central bank’s credibility is underscored by the fact that, despite the war, headline inflation is expected to stay within the mandated band.

The duration of the West Asia conflict will be critical, as prolonged high energy prices could force policy tightening. The monsoon’s performance, particularly under the shadow of potential El Niño conditions, poses a significant risk to food inflation, which has so far been contained by strong rabi output. Global commodity cycles beyond oil also remain volatile, adding another layer of uncertainty to the inflation outlook.

Steady Rates

The MPC’s decision to hold rates steady, coupled with its neutral stance and accompanying regulatory reforms, is expected to deliver distinct outcomes across different horizons. In the short term, the immediate effect is stabilization of market sentiment. By avoiding a rate hike, the RBI has shielded businesses from higher borrowing costs at a time when supply shocks are already straining margins. The decline in bond yields following the announcement underscored how well the “pause” was received by fixed-income markets.

Over the medium term, particularly in Q2 and Q3 of FY27, the decision will be tested as inflation is projected to climb toward 5.2 percent. The central bank’s challenge will be to prevent this headline spike from spilling into core inflation and unsettling household expectations. The neutral stance provides flexibility, allowing the MPC to act decisively if conditions worsen in the months ahead.

In the long run, the measures are designed to strengthen structural resilience. Governance reforms, regulatory consolidation, and improved oversight of financial institutions aim to build a sturdier foundation for the economy. These initiatives are intended to support a return to a growth trajectory above 7.6 percent once geopolitical pressures ease, underpinned by a stable macroeconomic environment and a stronger domestic manufacturing base. In essence, the RBI’s calibrated approach seeks to balance immediate stability with long-term durability.

The West Asian conflict has unsettled India’s economy, with government measures offering only limited protection if the crisis drags on. The Prime Minister even cautioned it could resemble a Covid-like disruption, demanding preparedness. The first round of talks between Iran and the US has collapsed without much progress, and any hope of an immediate consensus appears remote, particularly in the wake of the erratic and confrontational posture of Donald Trump.

In this uncertain environment, the RBI has chosen to keep policy rates unchanged while intervening to manage currency volatility to contain risk. This measured stance underscores confidence in India’s resilient domestic fundamentals and its commitment to long-term stability. As Keynes aptly remarked, “It is better to be roughly right than precisely wrong.” Guided by this wisdom, the RBI’s cautious approach seeks to safeguard the economy’s strengths and ensure they endure over time

(The writer is a Chartered Accountant with a leading company in Mumbai. Views personal.)