India's RBI Faces New Inflation Challenge Amidst Rising Oil Prices and Monsoon Concerns

For much of the final two years of former Reserve Bank of India Governor Shaktikanta Das' tenure, the central bank appeared to be winning one of its toughest battles.

After navigating the economic fallout of the pandemic, supply-chain disruptions, weather-related shocks and the commodity surge triggered by the Russia-Ukraine war, inflation gradually moved away from crisis levels. By the time Das left office, policymakers were once again discussing growth, liquidity and rate cuts rather than emergency inflation-fighting measures.

Now, just months into Governor Sanjay Malhotra's term, that progress is facing a fresh test.

Even before borrowers could fully benefit from lower interest rates, market conversations had already begun shifting towards a different possibility: whether the RBI may eventually have to raise rates again. The trigger is a familiar one—rising oil prices and supply disruptions stemming from the conflict in West Asia, alongside uncertainty created by evolving US trade policies.

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The RBI's monetary policy review tomorrow is widely expected to result in a pause. But economists increasingly believe the bigger story lies beyond the immediate decision. The central bank is confronting a fresh supply shock that threatens to complicate its inflation outlook just as it had begun easing policy.

The challenge is not merely higher prices. It is the possibility that inflation expectations, which had largely stabilised in recent months, could begin rising again.

A battle Das spent years fighting

The RBI's inflation fight has been long and uneven.

Retail inflation breached the central bank's 6% upper tolerance band for much of 2022 as food and fuel prices surged following Russia's invasion of Ukraine. Between May 2022 and February 2023, the RBI raised the repo rate by 250 basis points to 6.5% in one of the sharpest tightening cycles in recent years.

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Those measures, combined with easing commodity prices and improving supply conditions, gradually brought inflation under control. By early 2026, attention had shifted from inflation management to supporting growth.

The latest conflict in West Asia threatens to reverse that narrative.

The escalation has reignited concerns over energy supplies moving through the Strait of Hormuz, a critical artery for global oil trade. Brent crude prices have risen sharply from recent lows, reviving fears that imported inflation could once again become a key challenge for policymakers.

The risk is particularly significant for India, which imports more than 85% of its crude oil requirements. Every sustained increase in global oil prices eventually affects transportation costs, manufacturing expenses, fertiliser subsidies and household budgets.

What begins as an oil shock rarely ends there.

In other words, the RBI is dealing with a problem that monetary policy cannot directly solve. Interest rates can influence demand. They cannot produce more oil.

The elephant RBI cannot ignore

That leaves policymakers facing a familiar dilemma.

For the RBI, the concern is not where inflation is today, but where it may be headed. After touching a recent low of 2.74% in January, retail inflation has climbed for three consecutive months to reach 3.48% in April. The worry lies beneath the surface. Wholesale inflation has jumped to 8.3%, fuel and power inflation has surged nearly 25%, and food inflation has started edging up again. For the RBI, the fear is that today's producer-price shock becomes tomorrow's consumer inflation problem.

"WPI increased to 8.3% in April 2026 on the back of a supply shock. Monetary tightening will not produce an extra barrel of oil or gas," said Rajnish Gupta, Partner, Tax and Economic Policy Group, EY India.

If rates are raised aggressively, borrowing costs increase for businesses and consumers, potentially slowing growth. If rates remain unchanged for too long, companies may pass on higher costs to customers and inflation could become more entrenched.

Dharmakirti Joshi, Chief Economist, Crisil Limited, said signs of cost pressures are already emerging.

"CPI and core inflation remain within comfort zones, but WPI inflation rose to 8.3% in April, indicating rising input costs that may pass through to consumer prices. Companies might raise prices if the conflict persists, and recent petrol and diesel price hikes will also impact inflation."

For central bankers, the larger concern is what happens after the initial shock.

Temporary inflation is often manageable. Inflation expectations are harder to control.

If households begin expecting prices to keep rising, they demand higher wages. Businesses anticipating higher costs raise prices in advance. Consumers accelerate purchases because they fear things will become more expensive later.

That is when inflation starts feeding itself.

"The issue really in this case is of second order effects and of anchoring inflation expectations. If the public believes that prices will continue rising, then inflation will acquire a momentum of its own through wage-price spirals," EY’s Gupta said. "It is this secondary, expectational inflation and not the primary, supply-driven fuel inflation which the MPC must above all prevent from taking hold."

That challenge may become Malhotra's first major policy test.

Why the rupee has become a key variable

The RBI's concerns extend beyond inflation.

Higher oil prices worsen India's trade balance by increasing the country's import bill. They can also pressure the rupee at a time when global investors are already cautious.

"Confidence in currency is imperative. Volatility in rupee affects investment decisions and capital flows, increases inflation and negatively impacts fiscal position and makes planning more difficult. The rupee needs to be stable for all these reasons," Gupta said.

The pressure is already visible in capital flows.

According to ICRA, net foreign portfolio outflows across equity, debt and hybrid segments widened sharply following the outbreak of the West Asia conflict.

"Following the onset of the West-Asia conflict, the net FII outflows across equity, debt and hybrid segments have swelled to $21.0 billion during March-April 2026. Overall, the expected material deterioration in the CAD, along with weak net capital inflows is set to result in a drawdown in India’s forex reserves in FY2027," said Aditi Nayar, Chief Economist, ICRA, and ICRA Research.

ICRA estimates India's current account deficit could nearly double to around 1.7% of GDP in FY2027 if crude averages $85 per barrel. "This too, would be susceptible to sizeable upside risks, with every $10/barrel increase in the average crude price widening the CAD-to-GDP ratio for the fiscal by 30-40 bps."

While the RBI is unlikely to defend any specific exchange rate, economists believe it will remain focused on preventing excessive volatility.

"While RBI does not have a currency target, for the moment, it should use the foreign exchange reserves to reduce volatility and avoid undue depreciation," Gupta said.

The risk goes beyond oil

The economic impact of the conflict is not limited to energy prices. Disruptions to shipping routes, uncertainty over supply chains and rising geopolitical risks are increasingly affecting business sentiment.

"The effective closure of the Strait of Hormuz has constrained oil and gas supply and other supply chains and impacting some businesses negatively, spiking energy prices and putting pressure on current account, inflation and fiscal position," Gupta said.

ICRA sees a broader danger if disruptions persist.

"A similar scenario is unfolding in the ongoing West Asia crisis, amid blockage of the Strait of Hormuz. While energy prices have spiked, supply chains have been disrupted only for a section of manufacturing and services, particularly those dependent on natural gas. However, a prolonged supply shock can transmit to lower incomes and dampen confidence and sentiment. This could thereby generate a demand shock, as higher inflation impacts the discretionary incomes and demand of households."

Higher fuel costs raise transportation expenses. Transportation costs push up prices of goods and services. Household budgets come under pressure. Consumers reduce discretionary spending. Businesses delay investments.

Over time, growth slows even if the original shock came from outside the economy.

The monsoon wildcard

The RBI is also monitoring another factor beyond its control. The monsoon.

The weather risk is no longer a distant possibility. In its latest update, the India Meteorological Department (IMD) lowered its southwest monsoon forecast to 90% of the Long Period Average (LPA), down from its earlier estimate of 92%, citing the increasing likelihood of El Niño conditions developing during the monsoon season.

The weather office has warned that the probability of El Niño rises to more than 80% by June and exceeds 90% by July-August, raising concerns about weaker rainfall, lower farm output and higher food prices.

"Moreover, a potential development of El Nino conditions and below-normal monsoon would adversely dampen the prospects of the agricultural sector," Nayar said. "Besides, a potential El Nino can worsen agricultural outcomes and exert upward pressure on food prices and headline CPI prints in H2 of the ongoing fiscal."

The forecast is significant because it marks India's weakest monsoon outlook in more than a decade. Nearly half of the country's farmland remains dependent on rainfall, making monsoon performance a key determinant of food inflation, rural incomes and overall economic growth. Economists, as per a Reuters report, estimate that a deficient monsoon could push retail inflation closer to 5.5% from 3.48% in April if food prices begin rising sharply.

RBI’s outlook matters more than ever

For now, economists broadly agree on the RBI's immediate course of action.

"The RBI is expected to keep the repo rate and stance unchanged in the upcoming monetary policy. Inflation risks are tilted upward, likely influenced by the ongoing West Asia conflict, which has lasted three months," Joshi said.

The expected pause, however, masks a growing shift in market thinking.

At the start of the year, investors were debating how many more rate cuts the RBI could deliver. Today, economists are increasingly discussing when the next hike could arrive.

"Thus, while MPC is expected to remain data and development dependent, we believe that a pause is likely over the next few MPC meetings. Although the next move on rates is likely to be a hike rather than a cut, the timing of the same would be back ended, given the expectations of a larger hit to growth in the near term," Nayar said.

In all, the RBI cannot lower global oil prices. It cannot reopen disrupted shipping routes. It cannot influence geopolitical conflicts. What it can do is ensure households, businesses and investors continue believing that inflation will eventually return to target.