RBI Seen Avoiding Rate Hike Route Despite Rupee Pressure

The Reserve Bank of India is not considering interest rate hikes as its primary response to the sharp depreciation in the rupee, according to people familiar with the central bank’s internal discussions, even as financial markets price in tighter monetary policy over the coming months.

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The rupee has weakened nearly 6% since the escalation of the Iran conflict earlier this year and touched a record low of around 96.96 against the U.S. dollar this week. Despite the pressure on the currency, officials are understood to be prioritising inflation trends and economic growth over aggressive rate action.

According to people aware of the matter, the central bank believes there are alternative measures available to stabilise the currency market without immediately increasing borrowing costs. These measures include potential foreign currency deposit schemes for non-resident Indians and changes aimed at improving overseas investor participation in debt markets. Officials are also said to be working with the government to assess policy options, reports say.

Markets Pricing In Tightening Expectations

Interest rate swap markets are currently factoring in at least 40 basis points of policy tightening over the next three months and more than 100 basis points over the next year as investors assess inflation risks linked to elevated crude oil prices.

However, policymakers reportedly remain unconvinced that moderate rate increases would significantly strengthen the rupee. According to people familiar with the discussions, a meaningful defence of the currency would require sharper hikes, which could weigh on domestic demand and economic activity.

The RBI has historically relied more on forex intervention and liquidity measures than policy rate increases to manage currency volatility. Apart from a temporary tightening step during the 2013 currency crisis, the central bank has generally avoided using interest rates as a direct tool to support the rupee. The central bank has not officially commented on the matter.

Inflation Risks Remain Under Watch

India’s consumer price inflation stood at 3.48% in April, remaining within the RBI’s target range of 2-6%. However, rising crude oil prices and the weakening rupee are expected to increase imported inflation risks in the coming months.

Wholesale inflation accelerated to 8.3% in April, largely due to higher energy-related costs. Policymakers are monitoring the extent to which rising input costs pass through to consumers and affect broader inflation readings.

The RBI’s Monetary Policy Committee is scheduled to announce its next policy decision on June 5. According to people familiar with recent consultations between the central bank and economists, Governor Sanjay Malhotra raised questions around whether policy action may need to account for transmission lags in inflation management.

The RBI had projected India’s GDP growth at 6.9% for the current financial year in April. According to people aware of the discussions, that estimate could face downward revisions if global commodity prices remain elevated and external risks persist.