DBS Group Research economist Radhika Rao states that surging energy costs and a widening current account deficit are exerting immense pressure on the Indian Rupee (INR), pushing USD/INR toward new highs. Despite these stagflationary headwinds, Rao expects the Reserve Bank of India (RBI) to keep interest rates unchanged in 2026, opting instead to defend the currency through active FX interventions and targeted liquidity measures.
Bar for rate hikes is high
“USD/INR came within striking distance of 94.00 on Monday, closing at 93.95-93.98 (fresh low for INR) tracking a rise in oil prices. Rupee weakness reflects a cyclical adjustment in response to evolving global conditions, primarily a shift in underlying external sector dynamics.”
“As a net importer of oil and other key energy commodities, the country faces the twin headwinds of a wider current account gap and weak capital inflows, in the face of high prices and delayed supplies. As costs adjust, incipient inflationary pressures are also likely to surface.”
“While volatile portfolio inflows had weighed on the currency prior to the Middle East tensions, a surge in energy prices in wake of the recent conflict threatens to widen the current account gap via a wider import bill and slower remittance inflows, cumulatively leading to a second consecutive year (a first) of BOP deficit in FY26.”
“The bar for rate hikes is high, in our view. In the context of this stagflationary shock and exogenous nature of the event risk, we expect the RBI to keep rates on hold in 2026, while addressing specific pockets of strain.”
“Banking system liquidity returned to a modest deficit in midst of advance tax outflows and strong FX intervention. In a third such tranche this month, the RBI infused INR 793bn via an overnight VRR auction yesterday (vs notified INR 1trn) and announced plans for a 3-day auction on Tuesday worth INR1trn; more are likely if the defense against rupee weakness continues. “
(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)
Source: https://www.fxstreet.com/news/usd-inr-stagflation-risks-keep-rbi-on-hold-dbs-202603240727
