How West Asia War Shock Could Shape RBI’s Next Rate Decision

The Reserve Bank of India’s first Monetary Policy Committee meeting of this financial year begins today. The global and domestic economic environment has changed drastically since the last MPC meeting in February. The rate-setting panel held the benchmark repo rate steady at 5.25% in February, after a cumulative cut of 125 basis points in 2025. With inflation expected to rise, macroeconomic indicators under stress, the rupee depreciating over 4%, and no signs of a de-escalation in the war in West Asia, the MPC is likely to shift the focus from the ‘Goldilocks phase’ to inflationary and growth impacts, exchange rate movements, and liquidity measures.

According to economists, the RBI is likely to hold rates steady at its policy decision on April 8. “We expect RBI to stay on pause as inflation remains below 4% for now,” Gaura Sengupta, chief economist at IDFC First Bank, said. “The West Asia crisis, which is a combination of price and quantity shock, will pose downside risk to growth. Moreover, from an FX (foreign exchange) perspective, what is needed are measures to attract capital inflows.”

What Changed From Last Policy Meeting?

The last policy meet was in early February, when the central bank kept the repo rate policy stance unchanged and revised the inflation projection upward amid an evolving geopolitical situation and heightened uncertainty. For the quarter ending June, the RBI projected inflation at 4%, the target level the central bank aims to maintain. For the same period, growth was projected at 6.9%.

However, on February 28, the US and Israel launched a combined military attack on Iran over its nuclear programme development. Iran’s response was a cold shutdown of the Strait of Hormuz, a vital waterway serving nearly 25% of global energy trade. The near-complete closure of the Strait has rattled global markets, sent crude prices to multi-year highs, and pushed the rupee past the psychologically crucial 95-per-dollar mark. The rupee has depreciated nearly 4% since the conflict.

India has been particularly vulnerable owing to its heavy dependence on oil and gas imports. The fall in the rupee further weighs on India’s import bill, risking a further widening of the current account deficit and a slowdown of the economy. Economists and analysts across the globe have cautioned that if the war prolongs beyond April, it could risk triggering a global recession.

How Has the Market Responded?

The global crude market has been one of the most volatile since the conflict erupted. The benchmark Brent crude rose as high as $119.4 per barrel, hitting multi-year highs and compelling the International Energy Agency (IEA) to release emergency oil reserves. On March 11, the IEA announced its largest-ever coordinated release of over 400 million barrels to prevent crude prices from breaching the crucial level of $150 per barrel.

Domestic financial markets have also borne a huge brunt. Amid heightened uncertainty and escalating tensions, foreign portfolio investors staged a mass exodus. As per data from NSDL, FPIs withdrew $2,327.72 million from the Indian market on April 1. They have withdrawn ₹1.37 lakh crore in March and April so far.

The Indian rupee depreciated faster than expected, triggering intense market intervention from the RBI. Last week, the central bank asked banks to cap their net exposure to the rupee at $100 million by the end of each trading day, starting April 10, in a move to limit the pace of rupee's depreciation.

Further, India’s forex reserves fell by $30.5 billion since the West Asia conflict, as the RBI intervened in the market to curb excess volatility. Total reserves fell $10.28 billion to $688.05 billion during the week ended March 27, on the back of a decline in foreign currency assets and gold reserves. The spike in oil prices has led to a rise in bond yields. The benchmark 10-year yield has crossed the 7% mark amid inflation worries.

Is a Rate Hike on the Table?

According to economists, the MPC is expected to maintain status quo in April. As per reports citing analysts, a rate hike is unlikely as retail inflation remains under control. “As per our (IDFC First Bank) FY27 CPI inflation estimate, inflation is at 4.9%. This implies that headline CPI does not cross 6%, which is the upper threshold of the inflation-targeting band. In the past, the RBI has hiked policy rates in response to a supply shock only when inflation has been above 6% for a few months,” Sengupta said. Madan Sabnavis, chief economist at Bank of Baroda, said that one rate hike is possible to tame the risk of imported inflation. The RBI has a primary mandate to maintain price stability by targeting inflation at 4%, with a tolerance band of +/- 2%.

“The one-year OIS is pricing in more than five rate hikes, reflecting market concerns over inflation. Moreover, post the RBI’s net open position limits for banks, market rate-hike expectations have increased further, as the move was seen as a sign of concern over the currency,” IDFC First Bank said in a note.

Market to Focus on Forecast

Market participants have largely priced in a pause in the repo rate and policy stance. Instead, they are expected to focus on growth and inflation projections and forward-looking guidance by RBI Governor Sanjay Malhotra. According to reports, global uncertainty, elevated commodity prices, and supply-chain disruption are likely to complicate the inflation outlook. “The inflation trajectory remains vulnerable to global commodity price movements, particularly amid ongoing geopolitical tensions in West Asia,” ratings agency ICRA said in a report. “Energy prices are unlikely to revert to the levels seen in February 2026 in the near term, even if there is rapid de-escalation.”

“Monetary policy will need to ensure that the flow of credit is maintained in the economy, especially to at-risk sectors such as exporters and MSMEs. The tone of the policy will need to remain neutral to prevent further tightening of domestic financial conditions,” Sengupta said in the note. It also added that the central bank may need to deploy ‘unconventional measures to defend the INR,’ given the uncertainty on the duration of the conflict.