One More Pause Before a Hike

Not much has changed since the last policy.

First, the usual crude oil price volatility continued amid reports of a maritime embargo against Saudi Arabia. Prices subsequently stabilised following new global policy initiatives aimed at building a maritime defence partnership between Saudi Arabia and 13 other nations. This level of volatility in oil prices has already been priced in by the RBI, as reflected in the scenario analyses in the April 2026 Monetary Policy Report.

Second, the tightness in system liquidity persisted, with liquidity remaining below 1% of NDTL. It currently stands at 0.5% of NDTL, based on NDTL as of July 15. Third, the buoyancy in credit growth has been maintained. Fourth, the rupee has depreciated moderately against the dollar amid persistent dollar strength.

Against this backdrop, the RBI is likely to maintain the status quo on both rates and the policy stance. The policy is likely to serve primarily as a forward signal, setting the stage for an imminent rate-hike cycle.

Rate Hike: Why Later, Not Now?
CPI inflation averaged 3.9% in the first quarter of 2026–27, undershooting the RBI’s projection of 4.2%. The RBI is likely to evaluate this carefully and reassess the future CPI trajectory.

Since the last policy, inflationary risks have become more balanced as the southwest monsoon picked up pace in July 2026. Rainfall was 2.8% below the long-period average in July 2026, compared with 39% below it in June 2026. On a cumulative basis, rainfall is now 14% below the long-period average as of July 30, 2026.

The area sown under kharif crops as a percentage of the normal area, as of July 24, 2026, was a tad lower than in the same period last year. There is also time for sowing to pick up in August.

Arrivals of TOP vegetables, comprising tomatoes, onions and potatoes, which have exhibited significant volatility in CPI in the past, were favourable during April–July 2026. Hence, no significant supply-side constraint is yet visible on the food inflation front. However, India’s dependence on edible oil imports needs to be monitored closely, as international edible oil prices are elevated because of weather-related disruptions and firm biofuel demand.

Core inflation data, which primarily capture the demand-side aspect of inflation, have remained range-bound between 3.7% and 3.9%. Abridged core inflation, which excludes pan, tobacco, gold, silver and other precious metals, is considerably lower, at 2.3%. Hence, the second-order pass-through of higher inflation through the demand channel remains muted, as supply conditions remain favourable.

On the growth front, the first quarter is expected to post a robust number, as high-frequency data show improvement. From higher auto sales and non-oil, non-gold imports to increased electronics imports, double-digit growth in power demand and strong corporate net sales in the first quarter, the expansion is broad-based.

The RBI is therefore likely to take note of this and wait for the first-quarter GDP data before deciding on rates.

Domestic yields have softened since the previous policy, primarily supported by policy measures to attract capital inflows. During June and July 2026, up to July 30, net FPI debt inflows amounted to $8.4 billion, far exceeding the cumulative net inflow during January–May 2026. Any immediate rate action could therefore come as a surprise to the bond market and push yields higher.

What Will Support a Future Rate Hike?
It will be crucial to watch for any revision to the RBI’s quarterly inflation forecasts. In particular, any upward revision to the third-quarter forecast may be read as indicating a higher probability of the rate-hike cycle beginning in October 2026.

The spatial distribution of the southwest monsoon remains a key factor affecting crop arrivals in major states with low irrigation coverage. On a cumulative basis so far, 36% of the country’s area is experiencing deficient rainfall. Hence, concerns about elevated inflation cannot be dismissed entirely. The evolution of data in the coming months will give a clearer picture.

On the banking liquidity front, the deficit, defined as incremental deposits and borrowings net of incremental credit and investment, is elevated at ₹3.8 trillion as of July 15.  However, the effect of FCNR(B) deposit flows is yet to become visible, as the SCB data are available with a lag.

A rate hike could help attract more deposits and rebalance banking liquidity at a time of significant credit demand.

To sum up, the current policy is likely to carry a more hawkish tone than earlier policies. There remains scope for at least one or two rate hikes during the cycle. The nine-month OIS, hovering at about 5.8%, also points in the same direction. 

* Views are personal