Radhika Rao – Executive Director and Senior Economist, DBS Bank
The outlook for domestic interest rates remains tilted towards a prolonged pause from the Reserve Bank of India (RBI), as the rising geopolitical tensions in the Middle East and elevated oil prices continue to keep sentiment under check, DBS Bank Executive Director and Chief Economist Radhika Rao said.
In an email interview with Moneycontrol, DBS’ Rao warned of an upside to inflationary pressures in the coming months, should oil prices remain elevated at more than $70 per barrel for a sustained period of time.
However, she also pointed towards a banking liquidity surplus in the system, supported by incremental easing measures. Hence, there are also expectations that the RBI will now look to absorb excess liquidity in the system later this month, according to Rao.
With the current geopolitical tensions in the Middle East and the escalation in oil prices, where do you believe interest rates are headed locally?
The previous MPC review indicated a neutral stance and noted that any action on interest rates would be contingent on future developments.
The decision to hold rates at the February meeting reflected the policy committee’s generally constructive assessment of growth and inflation dynamics. Policy transmission has been uneven, with the reduction in the repo rate more clearly reflected in external benchmark-linked rates, while market-based borrowing costs remain relatively elevated. Deposit mobilisation has seen some impact amid headwinds. In addition, further rate reductions could increase the likelihood of repatriation by rate-sensitive portfolio flows.
Looking beyond February, we expect the RBI to maintain a prolonged pause, supported by a positive cyclical upswing and confidence effects following the successful conclusion of US trade negotiations and the subsequent US ruling that lowered the effective tariff rate. Against the backdrop of prevailing geopolitical risks, we do not anticipate a change in the policy stance at this stage, with the extended pause likely to continue.
Do you expect risks arising from these recent events to subside soon?
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The duration and intensity of the conflict will be key in determining the extent to which risk appetite is affected and the degree to which elevated energy prices weigh on demand. At present, markets appear to be factoring in a relatively swift de-escalation of tensions. If hostilities were to end within a fortnight, as seen in June 2025, markets could recover quickly. However, any escalation of the regional conflict or a potential disruption to the Strait of Hormuz would have broader macroeconomic implications.
India has diversified its crude oil supplier base to include Russia and the US compared with earlier oil shock episodes, which provides a degree of cushioning. If oil prices average within the $75 to $80 range, the impact is likely to be limited, with oil marketing companies expected to absorb incremental costs. A sharper and sustained rise above the central bank’s baseline assumption of around $70 per barrel could pose an upside risk of roughly 30 basis points to inflation, assuming excise duties remain unchanged.
In the absence of a sharp increase in global fuel prices, authorities are likely to take a measured approach to passing on higher costs to consumers. Considerations around preserving household purchasing power, supporting businesses and a busy state election calendar in the first half of the year may contribute to a gradual approach to retail fuel price adjustments. A secondary impact could emerge through remittances, and in turn the current account, if hostilities were to persist for several months, which we currently view as a low-probability scenario.
There was a significant expectation that the RBI would introduce liquidity-infusing measures before. Do you believe the system currently has ample liquidity? What should the RBI focus on going forward?
Banking system liquidity has remained in surplus, with a series of quasi or incremental easing measures keeping call rates around 25 basis points below the repo rate and moderating short-term funding costs.
The authorities’ preference to maintain surplus liquidity, as reflected in the weighted average call rate remaining below the repo rate, appears aimed at easing money market conditions and mitigating funding pressures in March, which marks the end of both the quarter and the fiscal year. As a result, there is an expectation that steps to absorb excess liquidity could resume early in the next financial year.
Scheduled maturities, together with pandemic-related bonds, have contributed to a sizeable pipeline of upcoming bond redemptions, ahead of which the scale of bond switches has been increased. While this is likely to reduce total gross borrowing in FY27, it will add to the stock of longer-dated maturities. Cumulative switches in calendar year 2026 will add up to a bit above INR 1.4 trillion. In total, around INR 29.7 trillion of bonds are set to mature over the next five years.
Given the volatility in crude prices, what is your near-term view on the benchmark 10-year bond yields? Yields have remained stubbornly high since the beginning of the year. Should the RBI consider additional liquidity injections?
Our energy team has modestly revised up oil price forecasts for 2026/27 with a base case scenario of severe disruption for a month or so, followed by gradual normalisation. We assume more lasting damage to Iran’s oil production and export capabilities, which might tighten the global supply-demand imbalance persisting since 2H-2025, despite OPEC+ moves to accelerate the return of production increments following the pause in 1Q26. The longer the war persists, the worse for energy prices.
Domestic bond yields have remained elevated due to the underlying dominance of fiscal policy over monetary stance. State borrowings have been bunched up in 1Q26 (4QFY26). Secondly, besides an active central bank, other institutional buyers face hurdles. For instance, tepid replacement demand from banks and incremental interest from pension funds have leaned towards equities, and insurance companies are constrained by regulatory issues.
Add to this, the centre has rationalised the share of the long-term paper in its issuance mix (still higher than past trends), and states are yet to follow suit. We expect the authorities’ presence in the bond market to, nonetheless, cap yields in the near-term, while global developments are being watched closely, especially the direction of energy prices.
What is your near-term view on the country’s current account health?
On a sequential basis, India’s current account moderated in the 3QFY26 to 1.3% of GDP vs 1.4% quarter before, attributable to a sharp increase in invisible receipts, especially driven by service exports. Goods deficit, nonetheless, was also relatively wide, mainly driven by gold and non-oil gold purchases. On an annual basis, we expect the current account gap to be at manageable levels of -1.0% of GDP, boding well for external balances.
Assuming global risks dissipate, we expect export performance to fare better in FY27, helped by diversification trades and a lower effective US tariff rate. We are sanguine on the capital flow direction if geopolitical risks subside and investors seek non-AI bets in the region. While the total balance of payments might remain in red, we expect the shortfall to moderate from FY26 levels.