Sanjay Malhotra faces his first big test since assuming charge as Reserve Bank of India Governor almost two-and-a-half years ago and initiating a monetary easing cycle.

Along with the monetary policy committee (MPC) members, Malhotra may still find small space for an interest rate pause this time but a credit cycle reversal is inevitable down the line.

Economists say a case may be there for the MPC to hold off on rate hikes in the immediate June monetary policy but beyond that it will be tough to resist the signals of an upward curve. 

The only hope of avoiding the inevitable route to a rate hike is that the US-Israel war with Iran ends soon and oil prices tame. Not many, however, are optimistic of that taking place as US President Donald Trump oscillates between ‘a ceasefire call’ and ‘strikes on Iran’. Some economists even think that the way the economy and the geopolitics is evolving, a delay in increasing the repo rate can be counterproductive.

The matter to contest is when will the MPC decide to go for a rate hike and by how much. If June escapes the stick, the MPC could decide on a rate increase in August. The expectation among economists is that the repo rate would rise by 50-75 basis points by the end of the current financial year in possibly two tranches, depending on the longevity of the conflict in West Asia and the economic pain it causes.

India’s ‘Goldilocks’ phase, which took birth during Malhotra’s tenure with inflation staying low and growth accelerating, could be ending. The April headline inflation at 3.5% is within the RBI’s medium-term target of 4%, but it is rising and the impact of higher fuel prices is going to have a spiralling effect across manufactured goods and services. A cause of worry is also the wholesale inflation, which rose to 8.3% in April amid higher energy prices and rupee depreciation.

Growth, the other pot for the rate-setting MPC to consider, is slowing down. While trade flows are constrained, several sectors including airlines and hotels have started to feel the heat under the war drag. 

The RBI in its monetary policy this week is set to revise upwards its 4.6% inflation forecast for FY27 while lowering the year’s projected growth figure of 6.9%. Several economists are projecting inflation at 5% upwards for the year, depending on where crude oil prices end. 

Amid the Iran war and closure of the Strait of Hormuz, India’s inflation is at risk of broadening into a persistent problem. A surge in oil prices and supply disruptions have raised inflationary expectations while a below-normal monsoon forecast due to El Nino could adversely affect crop output.

A weak rupee, moving around a series of historic lows against the dollar in 2026, also raises inflation risks. According to the RBI in its April monetary policy report, a 5% depreciation in the Indian rupee relative to the baseline scenario adds 40 basis points to headline inflation.

The other factors Malhotra and his team have to consider are persistent foreign fund outflows and the threat of a current account widening. The US Federal Reserve may also opt for a rate hike, narrowing further the interest rate differential between the two countries from its current level of 2.5 percentage points. This can lead to more capital outflows.     

When Malhotra and the MPC members sat for fixing interest rates last time in April, the US-Iran war had already started but it was easier to decide on keeping the repo rate unchanged. Nobody then objected to a ‘wait-and-watch’ policy. Two months later, that choice has narrowed as the Iran war has prolonged. Embracing a rate increase seems to be the only pragmatic step to take in future, even if it is averted this time.