The Reserve Bank of India is not ignoring inflation. It is doing arithmetic

THE RESERVE Bank of India keeps its policy rate at 5.25%, a level that has not moved since December last year, even as the European Central Bank, the Reserve Bank of Australia, the central banks of Norway and Japan have all raised theirs. On the surface, the divergence looks like passivity. In practice, it is a calculation: the RBI has decided that hiking rates would do little to cure the inflation it faces, and much to damage the growth it is trying to protect.

The numbers behind the decision are uncomfortable. India's consumer-price inflation rose to 4.38% in June, its first reading above the RBI's 4% target since January 2025. Food inflation, a bigger driver of household pain, rose to 5.32% in June, according to the government's Consumer Price Index. The rupee, meanwhile, touched a record low of 96.96 against the dollar in May before recovering part of that loss to the low 95s. Foreign-exchange reserves, though still ample at $682bn, fell to a more-than-one-year low in late May as the central bank intervened to defend the currency.

A year ago, the picture was entirely different. In early 2026, inflation had fallen to 2.1%, its lowest level in years. The RBI was contemplating further rate cuts. Governor Sanjay Malhotra described the economy as being in a "Goldilocks" phase. Real GDP growth in the 2025-26 fiscal stood at 7.7%, propelled by robust domestic consumption, public capital spending and services expansion. Then the Strait of Hormuz effectively closed, oil prices spiked, and US tariffs from the previous year combined with Middle East hostilities to produce a shock that no amount of monetary tightening could have anticipated.

That is the key to the RBI's apparent stillness. The inflation it is fighting is not domestic demand running hot. It is the price of imported oil and the global supply disruptions caused by war. Raising interest rates does not reopen shipping lanes. It does not lower the price of crude, which India must import for nearly 80% of its needs. What it does is make borrowing more expensive at precisely the moment when growth is slowing. The RBI has downgraded its GDP forecast for the current fiscal to 6.6% from 6.9%. Fitch, a rating agency, cut India's outlook to 6.4%. The OECD sees growth as low as 6.3%. The IMF, writing in July, pointed to a widening war and a monsoon weakened by El Nino as further downside risks.

To be sure, inaction carries its own costs. A currency that has fallen nearly 7% against the dollar in a year makes imports more expensive, which feeds further inflation. Higher inflation erodes real incomes, which in turn drags on consumption, India's main source of demand. There is also the risk that inflation expectations become unanchored, forcing a more painful adjustment later. And in a world where developed-market central banks are hiking, the opportunity cost of keeping rates steady widens, making Indian assets less attractive to foreign investors at a time when they are already fleeing.

Yet the alternative - hiking to defend the rupee or to signal toughness - would be worse. The incentive structure is straightforward. If the RBI raises rates by 25 or 50 basis points, borrowing costs for an already-slowing economy rise. Credit demand falls. Investment in capital goods and infrastructure, which has been one of the few bright spots, slows further. The government's ambitious public-spending programme, which accounts for much of the current fiscal's momentum, faces a higher cost of financing. And none of this meaningfully reduces the price of oil or the trade deficit that is the rupee's primary problem.

The RBI has responded to currency pressures instead with a different set of tools. In June it announced one of the more significant capital-account liberalisation packages in recent Indian history. It expanded the fully accessible route for foreign bond investors to include all new 15-, 30- and 40-year government securities, removing concentration and investment limits for foreign portfolio investors under the general route. It raised equity-investment caps for non-resident Indians and overseas citizens of India. The government complemented these measures by cutting taxes on certain foreign investments in government bonds. Together, the measures have drawn roughly $20bn in inflows, enough to stabilise - but not reverse - the rupee's decline.

This is a more coherent strategy than rate hikes would have been. The rupee's weakness stems from a current-account and capital-account imbalance, not from a domestic inflation spiral. Liberalising capital flows addresses the capital-account side directly. It invites the dollar inflows that interest-rate differentials would have to work much harder and more expensively to achieve. Whether it is sufficient is another question. The rupee remains far from its January low of 89.86, and the measures' durability depends on the same two external variables that have driven the entire year: oil prices and the dollar's broader trajectory.

What the RBI's decision reveals is a deeper truth about monetary policy in an energy-importing emerging market. Central banks that hike in response to supply shocks are treating a structural problem as if it were cyclical. The European Central Bank's decision to raise rates reflects lessons from 2022, when it feared a repeat of an inflation surge that became embedded in wage and price expectations. India's situation is different. Its inflation is smaller in magnitude, more import-driven, and occurring against a background of slowing rather than overheating demand. The policy starting point is also different: India's real interest rates are not negative, and policy is already somewhat restrictive relative to growth.

The danger is not that the RBI is wrong today. It is that the window for patience may not stay open. If oil prices remain above $90 a barrel for long enough, food inflation keeps rising, and the monsoon proves weak, the arithmetic changes. Governor Malhotra himself said in July that it would be "premature" to discuss rate hikes, but economists noted that a sustained breach of 6% inflation would likely force the committee's hand. The IMF, Fitch and the OECD have all trimmed their growth forecasts. A fiscal that started as a Goldilocks story is being rewritten into something closer to stagflation - not full-blown, but close enough that the room for error shrinks.

The better answer for India's government is not to pressure the central bank into tightening. It is to reduce the economy's exposure to the shocks that are driving inflation in the first place. India imports most of its oil, many of its critical manufacturing inputs, and depends heavily on energy-intensive industries. The free-trade agreements it has signed recently will help diversify export markets, but they do not reduce import dependence in the short run. Structural reform - faster energy-transition investment, stronger domestic production in strategic sectors, and a fiscal stance that does not exacerbate demand during a supply shock - would do more to address India's vulnerability than any number of basis points of rate adjustment.

For now, the RBI's restraint is defensible. The inflation it faces is not the sort that interest rates cure. But defensible is not the same as safe. If oil stays high and the monsoon fails, patience becomes complicity. That bargain is not yet broken - but it is fraying.