The RBI is widely expected to keep rates unchanged in its August policy meeting. August will mark a hawkish pause, with the RBI keeping the window open for possible rate hikes in the October-December 2026 quarter. The reason is simple — the macroeconomic backdrop that justified monetary easing has changed materially. Inflation risks are rising, growth remains surprisingly resilient, credit expansion has reaccelerated, and global financial conditions and interest differentials may become less supportive in the period ahead. Taken together, these developments suggest that the current 5.25% repo rate may not remain appropriate for much longer. The next quarter might be the optimal window to initiate a rate-hike cycle. By then, the economy would have had sufficient time to absorb the cumulative impact of the last rate cut delivered in December 2025 while also reducing the risk of falling behind the curve.
India’s headline consumer-price inflation averaged 3.9% year-on-year (y-o-y) during the last quarter, below the RBI’s own forecast of 4.2%. But the key question for policymakers is not where inflation was in the second quarter, but where it is likely to be over the coming quarters. On that score, the outlook is less comforting. The RBI currently expects consumer price index (CPI) inflation to average 5.1% in FY27, while our own forecast stands at 4.9%. Either outcome at the current repo rate of 5.25% implies an ex-ante real policy rate below 50 basis points (bps), well below the 1-1.5% positive real-rate range that has historically been associated with macroeconomic stability.
Food prices remain the most obvious source of upside risk, led by the delayed onset of the monsoon this year. Kharif foodgrain sowing remains below last year’s pace, although recent data suggests some improvement compared with the sharp deficits recorded earlier in the season. History offers a clear warning. In drought years such as 2009, 2014, and 2015, delayed monsoons initially appeared manageable before ultimately feeding into weaker agricultural output and significantly higher food inflation. There is a risk that the same trend may follow this year too, though the jury is out on this.
But food prices are not the only source of concern. Imported inflation is re-emerging, which warrants caution. Elevated oil prices, disruptions linked to the West Asia conflict, and pressure on the rupee have pushed India’s imported inflation rate to around 8% y-o-y in June. While measures of core inflation, excluding volatile precious metals, remain relatively subdued, the RBI’s policy framework is centred on headline inflation. If global oil prices remain elevated, imported price pressures may exacerbate in the coming quarters.
Meanwhile, India’s growth momentum has held up well. Conventional wisdom suggested that geopolitical uncertainty and global trade disruption would slow economic activity during the first half of FY27. Instead, most high-frequency indicators point to resilient economic activity. Indeed, non-oil imports rose almost 19% y-o-y during the first quarter, while non-oil-non-gold imports, a proxy for domestic demand, increased roughly 17% y-o-y. Meanwhile, public-sector capital expenditure rose more than 13% y-o-y during the first quarter to Rs 2.5 lakh crore, continuing the government’s strategy of supporting growth through infrastructure spending.
Against this backdrop, there is a growing possibility that GDP growth exceeds the FY27 consensus forecast of 6.5%. Such an outcome was seen in FY26 as well. Indeed, FY26 growth ultimately reached 7.7%, and was substantially stronger than consensus forecasts prevailing at the beginning of that year, despite persistent tariff-related disruptions.
The rising gap between credit and deposit growth also warrants caution. Banking sector data points to a significant reacceleration in lending activity, likely reflecting the delayed effects of the RBI’s cumulative 125-bps easing cycle, generous liquidity support, and macro-prudential relaxation implemented through 2025. As of June, bank credit growth stood at 18.6% y-o-y, compared with deposit growth of only 13.3% y-o-y. That gap has pushed the credit-deposit ratio to 82.6%, up sharply from 78.9% a year earlier. Sectoral lending data reveal broad-based strength.
Further demand-side support is visible on the horizon. The implementation of the Eighth Pay Commission from the next fiscal is expected to raise salaries, pensions, and allowances for millions of government employees and retirees. It will provide a helpful boost to disposable incomes and household spending in 2027 and beyond. Because monetary policy operates with long lags, the MPC will need to account for this, while informing their future course of monetary policy decision.
Traditional policy frameworks suggest the same conclusion. A standard Taylor Rule exercise — using inflation forecasts close to 5%, growth forecast between 6.6-6.7%, potential growth of around 7.25%, and a desired positive real interest rate — points to a terminal repo rate closer to 6.0-6.25% than the current 5.25%. Even under a less inflationary scenario, with CPI inflation averaging 4.6% and growth at 6.9%, in line with the RBI’s April forecast, the implied terminal repo rate remains close to 6%. On this basis, a cumulative 75-100 bps of policy tightening appears justified over the cycle, taking the repo rate to 6-6.25% by mid-2027, compared to the current 5.25%.
History also provides a useful benchmark. Between FY17 and FY19, when inflation averaged below today’s projected levels and GDP growth was comparable, the repo rate typically remained between 6% and 6.25%.
The global backdrop could further strengthen the argument for policy normalisation. If the Federal Reserve is forced to resume tightening, interest-rate differentials, exchange-rate stability, and capital flows will assume greater importance. Several Asian central banks have already restarted tightening cycles. In such an environment, maintaining credible positive real interest rates will become increasingly important for India.
None of this means the RBI should raise rates in August. The case for patience remains persuasive. Policymakers will want additional evidence on monsoon developments, food inflation, April-June GDP growth, and global conditions before committing to a new policy cycle.
Yet the direction of travel appears increasingly clear. The conditions that justified low interest rates are disappearing. Inflation is projected to remain above target, growth is stronger than expected, bank credit is accelerating, and future fiscal measures are likely to boost demand further. The most likely outcome, therefore, is a hawkish pause in August followed by the start of a gradual tightening cycle during the December 2026 quarter.
Fixed-income markets have increasingly begun pricing in the possibility of a rate-hike cycle commencing during the December quarter. Any policy tightening delivered by the RBI during this period is unlikely to be disruptive for market sentiment. Against this backdrop, its communication strategy at the August policy meeting will be particularly important. Forward guidance that emphasises persistent inflation risks could play a critical role in preparing markets for a gradual normalisation cycle beginning later this year.
Disclaimer: The views expressed are the author’s own and do not reflect the official policy or position of Financial Express.