The Reserve Bank of India (RBI) is expected to keep interest rates unchanged at its upcoming monetary policy committee (MPC) meeting, even as the central bank grapples with a rapidly depreciating rupee, rising imported inflation and heightened geopolitical uncertainty, says a research note from State Bank of India (SBI).
In its pre-policy assessment released ahead of the 3rd June to 5 June 2026 MPC meeting, SBI Research said the central bank is likely to adopt a wait-and-watch approach amid a volatile global environment marked by persistent conflict in West Asia, elevated crude oil prices and significant capital outflows from emerging markets. The report also expressed concern over the pace of rupee depreciation, arguing that the currency has weakened beyond what domestic macroeconomic fundamentals would justify and may require stronger intervention from the RBI.
The report's central recommendation is for the RBI to maintain a status quo on policy rates while relying on liquidity management tools and foreign exchange interventions to address mounting pressures on the currency and financial markets.
Inflation Outlook Turns Less Comfortable
SBI Research cautioned that inflation risks are beginning to build after a period of relative moderation. While consumer price inflation is estimated to remain around 4.0%-4.1% in the current quarter, the report projects inflation could exceed 5% over the next three quarters of FY26-27, with risks skewed to the upside.
According to the report, higher fuel prices and a weakening rupee are likely to increase imported inflation. Recent increases in petrol and diesel prices are expected to add 35bps (basis points) to 40bps to domestic inflation, while imported inflation could rise sharply in May due to currency depreciation and higher global commodity prices.
The researchers estimate imported inflation could rise to about 7.3% in May from 6.34% in April, potentially exerting additional pressure on household budgets and business costs. Despite these concerns, inflation is still projected to remain within the RBI's tolerance band.
No Case for a Repo Rate Hike
Despite advocating stronger measures to support the rupee, SBI Research ruled out a repo rate increase, arguing that the current inflation-targeting framework does not warrant such a move.
Instead, the report suggested that RBI could deploy short-term liquidity tools and market operations to stabilise the currency. Measures such as 'operation twist', which involves the simultaneous purchase and sale of government securities of different maturities, could be used to influence short-term rates without altering the benchmark policy rate.
The report noted that some central banks operating under inflation-targeting regimes have used interest-rate-related tools to defend their currencies during periods of exceptional market stress.
Sharp Rupee Depreciation Raises Concerns
A key focus of the report is the Indian rupee's performance over the past few months. SBI Research described the pace of depreciation as unusually rapid, noting that the rupee weakened from 90 to 95 against the US dollar in just 152 days and touched 96.83 on 30 May 2026.
The report argued that the rupee's weakness appears disproportionate when compared with India's economic fundamentals and relative performance against other emerging-market currencies. It observed that the currency has depreciated more sharply than several peers, including the Chinese yuan, Brazilian real, Malaysian ringgit and South African rand, suggesting that factors beyond general dollar strength may be influencing market sentiment.
According to SBI Research, the rupee currently appears undervalued and has moved significantly away from levels implied by India's real effective exchange rate (REER). The report estimated that if the REER were to return to historical equilibrium levels, the rupee could potentially strengthen substantially from current levels.
Call for Stronger RBI Intervention
The report said India's foreign exchange reserves remain sufficiently large to support the currency despite recent declines. Foreign exchange reserves have fallen by around US$47bn (billion) since late February, including about US$15bn over the last fortnight, but still remain near US$680bn.
SBI Research argued that stronger and more sustained intervention by the RBI could help prevent a one-way slide in the rupee and reduce excessive volatility.
It pointed to episodes in March, April, and May in which larger interventions by the central bank appeared to provide temporary support to the currency. However, depreciation pressures quickly re-emerged, prompting the report to call for a broader balance-of-payments strategy that combines intervention, liquidity management, and other policy measures.
Global Risks Complicate Policy Choices
The report linked much of the current economic uncertainty to the ongoing conflict in West Asia, which has disrupted energy markets and fuelled risk aversion among global investors.
It noted that net foreign institutional investor (FII) equity outflows from India have reached about US$22.7bn since the conflict intensified, making India one of the worst-affected emerging markets in terms of equity outflows.
At the same time, elevated crude oil prices continue to pose a challenge. SBI Research expects oil prices to remain high for much of 2026, warning that crude could trade above US$90 per barrel for extended periods if geopolitical tensions persist.
The report also highlighted concerns over weather conditions, citing forecasts of a weaker-than-normal monsoon. Below-normal rainfall in key agricultural regions could create additional inflationary pressures, particularly in food prices, later in the year.
Growth Remains Resilient
Despite external headwinds, SBI Research maintained a relatively optimistic view on economic growth. The report expects India's GDP growth for FY25-26 to come in around 7.5%, with fourth-quarter growth estimated at about 7.2%. For FY26-27, the bank currently forecasts growth of 6.6%, although it cautioned that the outlook could change depending on geopolitical developments and incoming data.
Credit growth is also expected to remain healthy during the first half of FY26-27 before moderating later in the year due to base effects. Overall bank credit growth is projected at 13%-14% for the full year.
Focus on Liquidity Management
The report noted that banking system liquidity has tightened considerably in recent weeks, with surplus liquidity falling sharply from levels seen in April. However, it expects liquidity conditions to improve following the RBI's record dividend transfer to the government, which should eventually flow back into the banking system.
Against this backdrop, SBI Research said the RBI is likely to focus on liquidity management and financial stability rather than changing policy rates.
"The call is to hold rates and remain data-dependent," the report indicated, suggesting that the central bank's immediate priority will be balancing inflation risks, currency stability and growth concerns in an increasingly uncertain global environment.
