RBI expected to pause rates amid Iran war and market volatility

India’s central bank is expected to keep interest rates unchanged on Wednesday as policymakers assess the fallout from the war in Iran, which has put pressure on the South Asian economy and unsettled currency and bond markets.

The focus is likely to shift towards stabilising financial markets, with assurances of readiness to support the weakening rupee and inject liquidity to contain bond yields, according to economists and traders.

All but two of 71 economists in a March 23–26 Reuters poll forecast that the Reserve Bank of India will keep the benchmark repo rate unchanged at 5.25%.

The Reserve Bank of India’s Monetary Policy Committee has cut rates by a cumulative 125 basis points in 2025 but paused at its February meeting. RBI Governor Sanjay Malhotra said in December that India’s economy was in a “Goldilocks” phase, combining strong growth with low inflation, allowing the central bank to maintain a loose policy stance for an extended period.

That assessment has since been disrupted by the worst energy shock in decades.

“If the energy shock lingers, the growth drag could outstrip the price shock, reminiscent of the COVID-19 pandemic economy,” said Pranjul Bhandari, chief India economist at HSBC, in an April 2 report.

She added that the combination of weaker growth and rising inflation supports a “neutral policy” stance that neither stimulates nor restrains demand.

In contrast, financial markets have begun pricing in a more hawkish risk scenario. Since the Iran war began, traders in the overnight indexed swap market have moved to price in the possibility of rate hikes, with one-month contracts reflecting expectations of a hike as early as this month.

Neeraj Gambhir, executive director for treasury, markets and wholesale banking products at Axis Bank, said swap rate pricing suggests investors assume the central bank may need to tighten policy to defend the currency.

Concerns over a widening current account deficit and foreign outflows have pushed the rupee to a record low past 95 per U.S. dollar.

The yield on India’s benchmark 10-year bond has risen to around 7.14%, its highest level in nearly two years, as investors factor in the impact of higher energy costs on government finances.

“We expect the RBI to continue injecting abundant liquidity into the system, ensuring easy financial conditions to help the economy tide over the shock,” said Aastha Gudwani, chief India economist at Barclays.

Barclays expects the RBI to continue bond purchases, short-term liquidity injections and longer-term foreign exchange swap operations.

The central bank has also taken steps to curb speculation in the foreign exchange markets.

Further measures to support the rupee, including a special forex swap window for oil companies or schemes to encourage inflows from non-resident Indians, cannot be ruled out, Gudwani said. She added that raising interest rates to defend the currency would not be the central bank’s first line of defence.

The RBI is due to present its first forecasts for growth and inflation for the 2026–27 financial year, and economists expect it to revise down its earlier outlook.

Much will depend on oil price assumptions, with economists outlining different scenarios based on how long elevated prices and supply disruptions persist.

HSBC estimates GDP growth would slow to 6.3% from an expected 7% this year if oil prices average $80 per barrel, and to 6% if prices remain closer to $100.

Inflation, which cooled to 3.2% in February, is expected to average around 5% if oil prices stay near $100 per barrel.

“Rising inflation risks increase our conviction that the RBI will keep policy rates firmly on hold,” said J.P. Morgan chief India economist Sajjid Chinoy in a March report.

“The bar for any rate hike is very high and would require a sustained supply shock that pushes headline inflation well above target for the foreseeable future,” he added.

India’s inflation target was reaffirmed last month at 4%, with a tolerance band of plus or minus 2 percentage points.

(With inputs from Reuters)