RATE HIKE UNLIKELY; RATE GUIDANCE LIKELY

RATE HIKE UNLIKELY; RATE GUIDANCE LIKELY

The upcoming RBI MPC meet from 03-Jun to 05-Jun will culminate in the monetary policy statement on Friday. With annual inflation pegged at above 5% for FY27, the RBI MPC has been under pressure to hike rates. After all, managing inflation expectations is as important as managing actual inflation for the RBI. However, there is another side to the story, which is the growth story. Nominal growth has already been under pressure and while nominal growth is likely to improve in FY27, higher inflation could dent the real GDP growth.

The most likely scenario is that the RBI may avoid a rate hike in June and prefer to give rate guidance. Raising rates at this point may not add value since the full picture of the monsoon shortfall is not clear. That will only be clear by the time the August monetary policy is presented. In addition, out of the 5% inflation expected for FY27, around 7.5% will be contributed by imported inflation, where rate hikes cannot play a big role. To be on the safer side, the RBI may prefer to wait and watch in June and take a call in August.

RECAP OF KEY ANNOUNCEMENTS OF APR-26 MONETARY POLICY

Here are key highlights of the April 2026 policy statement.

RBI MPC held the repo rate at 5.25% in the February meeting; and kept the stance of the monetary policy at Neutral. This also held SDF rate and MSF/Bank rate at same levels.

The FY27 GDP growth estimate was cut by 50 bps to 6.9%; to reflect the supply chain constraints caused by the conflict in the Middle East.

The inflation forecast for FY27 was raised by 40 bps to 4.6%, to reflect higher prices of crude oil and the impact of the El Nino on food inflation this year.

Let us turn to the specific expectations from June 2026 monetary policy.

WILL RBI HIKE RATES, OR HOLD RATES IN JUN-26 POLICY?

While a rate cut is almost ruled out at this juncture, the RBI has to toggle between a rate hike and holding status quo on rates. There is a strong case for a rate hike. Crude oil prices have surged from $70/bbl to above $100/bbl, and imported inflation is now contributing around 7.5% annually. Also, the IMD has reduced the monsoon forecast from 92% to 90% of LPA. This implies that food inflation could accelerate from June onwards.

Despite the triggers, the RBI may choose to maintain status quo on rates. The RBI will not want to upset the growth applecart at this stage, when a recovery in domestic consumer demand holds the key. By the time of the August monetary policy, there will be more inflation data points, including the impact of El Nino on food inflation. In June, the RBI is likely to hold status quo on rates, but give guidance of possible rate hike in the future.

WILL RBI CHANGE ITS STANCE TO “ACCOMMODATIVE” IN JUN-26?

If the RBI maintains status quo on rates, the best choice would be to keep the stance unchanged at “Neutral.” After all, an accommodative stance with a warning of rate hikes may be mutually incompatible. With a hawkish warning likely in the June policy, the RBI may prefer to maintain a consistent policy by holding the stance at “Neutral.”

Will the RBI MPC change the stance of monetary policy to a more Hawkish note to reflect higher rates? That may almost look like a double whammy for the markets and the RBI would prefer to avoid that. Most likely, June policy may be about status quo on rates, with a hawkish outlook, and stance maintained at neutral.

WILL RBI CHANGE FY27 REAL GDP GROWTH ESTIMATES?

In the previous policy statement in April, the RBI MPC had cut the GDP estimates for FY27 by 50 bps from 7.4% to 6.9%. Does the RBI see the need to cut rates further? The street consensus for GDP growth is veering towards 6.5% in FY27. The FY26 final GDP numbers will be out on 05-June, after the RBI policy. However, the fiscal deficit data presented by CGA indicate that nominal GDP for FY26 was lower than the revised estimate. While India GDP growth continues to be driven by domestic demand, the RBI may look to marginally tone down the GDP growth expectations to reflect the high level of macro uncertainty.

WILL RBI CHANGE FY27 INFLATION ESTIMATES?

In the previous policy statement in April, the RBI MPC had sharply raised the headline inflation estimates for FY27 by 40 bps to 4.6%. However, this is much lower than the median guidance of 5.0-5.5% inflation for FY27. Even the recent imported inflation has shown a spike at around 7.5%, so the global pressure will be high. The RBI may look to hike the inflation estimates closer to 5.0% to reflect the imported inflation risk and also to factor in the likely impact of El Nino on food inflation.

HOW WILL RBI MANAGE THE LIQUIDITY IN THE SYSTEM?

Unlike in previous months, the domestic liquidity may not really pose a major challenge for the RBI. The recent dividend payment of ₹2.87 trillion by the RBI to the government should also help the liquidity in the system. The real challenge on the liquidity front may not be in making liquidity available, but in tweaking the yield spreads between the longer term and the shorter term. The need of the hour for the RBI will be to do more of Operation Twists to brings these yields in alignment. The most interesting part will be whether the policy will announce something big on the currency front?

WILL THE RBI HIKE RATES TO DEFEND THE RUPEE?

That is a possibility we cannot rule out in this policy but we will come back to that point in the end. What are the options available to the RBI to defend the rupee?

To begin with, it is not just a rupee fall, but a real rupee crisis. The USDINR touched a low of ₹96.86/$, before aggressive RBI intervention settled things. However, the recent fall in the rupee from 90/$ to 95/$ happened in just 5 months. That is the risky part.

Can the RBI continue to defend the rupee by selling dollars? That is not really helping beyond a point. For instance, since the start of the US-Iran war, Indian forex reserves have depleted by $47 billion. Clearly, dollar selling is not a long-term solution.

Will the RBI introduce a big bang FCNR deposit scheme for NRIs like in 2013? It may not suite India’s current narrative. In 2013, India was part of the “Fragile Five”, so it could afford to take desperate measures. Today, it is more of a growth story, and a high cost FCNR scheme may not fit into the scheme of things.

The one way out is an aggressive rate hike. Not a rate hike to contain inflation, but to defend the rupee. A rate hike will attract foreign flows and make the rupee dearer. It hits two birds with one stone, and the lag effect could contain inflation too. That looks like a tough call on paper; and it is. Remember, there is no precedent in the past of the RBI governor raising rates just to stem capital outflows and to defend the rupee.

The 3-day MPC meet commencing on 03-Jun will have an intense debate on handling inflation and also defending the rupee from falling further. We have to wait till 05-Jun for the final outcome.