RBI has done what it can with interest rates, but heavy lifting on inflation will fall on government

The decision of the Reserve Bank of India’s Monetary Policy Committee to hike interest rates was seeming increasingly inevitable in the run-up to its meeting that started on Monday (October 5, 2026). 

Inflation in the July-September 2026 quarter came in at 4.9% as opposed to the 4.7% predicted by the RBI in its previous monetary policy review. The main driver of this has been fuel and food inflation. Looking ahead, the RBI predicts inflation will be 6% in Q3 — its upper comfort limit — and 5.7% in Q4.

Global oil prices have been shooting up once again thanks to a resumption of military action in Iran following a brief ceasefire. While the oil marketing companies, at the behest of the government, have as yet refrained from passing this increase on to consumers, the longer this situation persists, the harder that eventuality will be to resist. 

The higher oil prices are already having an impact on overall price levels, and if this translates into higher fuel prices, that knock-on effect will only magnify. 

At the same time, El Niño and a deficient monsoon are pushing up food prices, a situation that is not likely to abate for the rest of this year. 

On the growth front, the RBI is clearly betting that the economy can handle a small increase in interest rates. The RBI has revised its GDP growth forecast for the ongoing financial year to 7.1% from the 6.7% projected in the August 2026 policy. This 40bps upward revision is mainly due to upward revisions to its estimates for Q2 and Q3 numbers. 

The central bank’s rate-setting body capped this off with a change in its stance — from ‘neutral’ to ‘calibrated tightening’. The thinking on this is clear: it is better at the moment to tackle inflation expectations than to attempt to tackle inflation itself. That is, signals can be as powerful as direct action.  

RBI MPC meeting highlights

This makes sense from the central bank’s point of view. Interest rates cannot tackle the primary causes of inflation, which are constrained supplies of food and fuel. However, rate-setting can be a potent tool to control demand and second-order inflationary effects. 

More expensive loans mean people and companies borrow less, and so the amount of money sloshing around in the system dries up somewhat. A 25bps hike is a nudge in this direction, and bigger hikes become stronger pushes. A more conservative stance, similarly, signals that the central bank stands ready to further increase rates in the future.

In other words, while the worst of the upcoming inflation is out of the RBI’s hands, it can still take steps to mitigate the harm and try to stop people’s expectations of the ongoing price rise from spiralling. That is what Wednesday’s (October 7, 2026) monetary policy decision was about. 

The RBI also has another aspect to consider while deciding interest rates — the outflows of dollars from the economy. Foreign portfolio investors have sold around $24.3 billion in the Indian markets so far in 2026. In 2025, that number was $11.8 billion. 

Higher interest rates cannot stop this outward flow, but they can buy the central bank a little more breathing room as FPIs hold off on pulling out in anticipation of higher interest rates and, thus, returns.

Overall, the central bank has done what it can at the moment. Most of the heavy lifting on inflation is going to fall on the government’s shoulders as it seeks to protect consumers from higher oil prices and mitigate the blow of dearer food supplies.