Amid rising crude oil prices driven by the ongoing West Asia crisis and mounting inflationary pressures, Axis Mutual Fund sees the possibility of only 25-75 basis points of "calibrated rate hikes" by the Reserve Bank of India (RBI), instead of an aggressive tightening cycle similar to the 2013 taper tantrum.

In a note titled India in a New Oil Shock Regime, Axis Mutual Fund said the current oil shock is largely supply-driven, making conventional monetary tightening less effective in stabilising the rupee. The report noted that currency depreciation cannot be addressed solely through aggressive rate hikes, particularly when inflation remains relatively contained compared with past crisis periods.

The Indian rupee has weakened nearly 6% against the U.S. dollar since the Iran conflict escalated in late February, emerging as one of the weakest Asian currencies. The local currency touched a record low of 96.96 against the dollar on May 20. According to market experts, the rupee could breach the 98 mark if crude oil prices rise to $120 per barrel in FY27.

“INR depreciation cannot be solved purely via rate hikes, need of the hour is to solve for INR depreciation. Aggressive hikes may damage India’s growth trajectory while offering limited support to the rupee, since the current oil shock is supply-side, not demand-side,” the report said.

Why oil prices matter for India?

India remains highly vulnerable to fluctuations in crude oil prices as the country imports nearly 85% of its crude requirements. The agency estimates that every $10 per barrel increase in crude prices could widen India’s current account deficit by 40-45 basis points of GDP, push inflation higher by 45-60 basis points, and increase fiscal pressure if the government cuts excise duties to shield consumers from higher fuel costs.

However, compared with earlier oil shock episodes such as the 2013 taper tantrum, the 2018 oil rally, and the 2022 Russia-Ukraine conflict, India’s macroeconomic fundamentals are significantly stronger in the current cycle. During the 2013 crisis, Brent crude traded between $105 and $115 per barrel, inflation surged to 9-10%, the current account deficit widened sharply to 4.8% of GDP, and foreign exchange reserves stood at nearly $275 billion.

In contrast, the current environment is characterised by relatively moderate inflation expectations of 4.5-6%, a current account deficit projected below 2% of GDP, foreign exchange reserves of nearly $700 billion, and a structurally healthier banking system. Analysts therefore expect the RBI to pursue a more measured policy response than in previous crises.

Can MSF hikes stabilise the rupee?

The report also highlighted that aggressive tightening alone may not effectively stabilise the rupee during periods of external stress. During the 2013 episode, the rupee continued to weaken even after the RBI sharply raised the Marginal Standing Facility (MSF) rate. Stability returned only after the central bank introduced the FCNR deposit facility, which attracted dollar inflows and eased pressure on the currency.

Axis Mutual Fund believes the RBI may instead rely on a broader set of policy tools, including liquidity management measures, forex intervention using reserves, administrative controls, and initiatives to attract dollar inflows through NRI deposit incentives, sovereign bond schemes, and overseas borrowings by public sector entities.

The report added that India enters the current crisis phase with stronger macroeconomic buffers, including healthier bank balance sheets, lower private sector leverage, improved fiscal credibility, and support from global bond index inclusion flows.

At the same time, the fund house cautioned that India may gradually be moving away from the “Goldilocks macro” environment of low inflation, low oil prices, and strong growth. It expects FY27 inflation to rise to 5-6% in a post-war crude scenario of $80-100 per barrel, while economic growth could moderate to 6-6.5%.

Over the past 10 days, state-run oil marketing companies have raised petrol and diesel prices by as much as ₹7.5 per litre amid firm global crude prices and rupee weakness. The latest increase included a ₹2.5 per litre hike on May 26 following earlier revisions on May 15, May 19, and May 23.

Global benchmark Brent crude is currently hovering near $98.8 per barrel, down around 5% over the past week amid optimism over a possible U.S.-mediated ceasefire and diplomatic progress involving Iran, which could ease concerns over disruptions to global energy supplies through the Strait of Hormuz.

(DISCLAIMER: The views and opinions expressed by investment experts on fortuneindia.com are either their own or of their organisations, but not necessarily that of fortuneindia.com and its editorial team. Readers are advised to consult certified experts before taking investment decisions.)