India central bank to stay on hold even as peers pivot to rate hikes

MUMBAI: India’s central bank is expected to keep interest rates unchanged this week, diverging from many of its global peers as inflation remains modest despite higher global oil prices while steps to support the rupee drive strong inflows.

Central banks in Europe, Australia, Indonesia, the Philippines, Singapore, South Korea and South Africa have raised benchmark borrowing costs since the U.S.-Israeli war on Iran began five months ago. The Federal Reserve and Bank of Japan, though, have kept rates on hold.

Although it may adopt a more hawkish tone, the Reserve Bank of India’s Monetary Policy Committee will hold rates steady on Wednesday, 68 of the 72 economists in a Reuters poll predicted.

Flexibility to stand pat — for now

While retail inflation accelerated to 4.38% in June, above the RBI’s 4% target for the first time in 17 months, it remained within the 2%-6% tolerance band the central bank uses to allow room to deal with short-term supply shocks.

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Core inflation, which excludes volatile prices of food and fuel, has also remained contained near 4%.

“Although core and underlying inflation have risen modestly, they remain within the RBI’s comfort zone. Consequently, a rate hike is unlikely in 2026 unless core inflation sustains above 4.5%,” Samiran Chakraborty, Citi’s chief India economist, said in a note.

RBI Governor Sanjay Malhotra told the Hindu BusinessLine newspaper in an interview published last week that signs of higher fuel prices feeding into more generalised inflation remain limited.

However, inflation expectations have risen, a central bank survey showed in May, suggesting that pressures are building. Wholesale inflation also climbed to 9.87% in June.

“The MPC is likely to shift language acknowledging risks of firmer inflation and policy action ahead, while maintaining a data-dependent approach,” said Tanay Dalal, economist at Axis Bank, adding that the RBI may retain a neutral stance.

Dalal expects the pressure visible on wholesale prices to pass through to CPI over a three-to-four-month horizon.

“While the MPC may be able to look through the initial signs of firming inflation, a sustained uptick, coupled with rising inflation expectations could gradually reduce the room for such flexibility.”

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The later the hike, the more the RBI will be ‘pushed’

Reflecting such expectations, interest-rate swap markets are pricing roughly 75 basis points of rate hikes over the next 12 months.

The rupee’s slide to a record low ahead of the June policy meeting had fuelled calls for raising rates to defend the currency, similar to steps taken by Indonesia and the Philippines.

Instead, the RBI announced measures such as scrapping capital-gains tax for foreign holders of Indian government bonds and sweetening dollar deposit schemes for non-resident Indians. The steps have attracted nearly $40 billion in inflows.

The measures helped spark a fleeting rally in the rupee, but the currency has come under pressure as renewed hostilities in the Gulf lifted oil prices.

This pressure will persist until the central bank raises rates, widening the rate differentials with major economies to raise the appeal of Indian assets for foreign investors, said Trinh Nguyen, senior economist for Emerging Asia at Natixis.

“If you compare India to similarly rated markets, it’s not the most compelling story from a real yields perspective,” Nguyen said.

“Fundamentally, I think the right call for India is higher rates. They are not going to do it (this) week but the longer they wait, the more they will be pushed to it.”