West Asia war: Here's why your borrowing rates may go up this year

Through 2025, the Reserve Bank of India’s monetary policy committee slashed the repo rate, the benchmark rate at which the central bank lends money to commercial banks, to 5.25% from 6.50% earlier.

With interest rates increasingly linked to external benchmarks like the repo, many home loan borrowers saw their interest rates reduce. If you were hoping your rates would decline further this year, then you might be in for a shock as rates are more likely to go up.

As we entered 2026, there were expectations that the MPC would leave rates unchanged for a while, having done the bulk of the rate cuts last year. However, the ongoing war in West Asia, which has led to a surge in oil prices and disrupted supplies, has thrown a spanner in the works. Experts now see the possibility of at least two or three hikes this year, unless the war ends soon.

Don't Miss: Petrol, diesel prices may be gradually increased further, say sources

Why interest rates may go up

After holding off for a couple of months, the government has finally increased petrol and diesel prices. Following a nationwide Rs 3 hike in petrol and diesel prices last week, rates have again been raised this week. For instance, in Delhi, petrol is up by 87 paise and diesel by 91 paise. This increase has been necessitated by the war. With the conflict showing no signs of ending, crude oil prices on Tuesday were holding around $109 a barrel.

Since India is dependent on imports for the bulk of its oil requirements, the price hikes were imminent. This will have a ripple effect, as public transport may become expensive, freight costs may increase and higher raw material costs will pinch companies, which have already begun passing on price increases in recent months.

RBI Governor Sanjay Malhotra had warned in April that the conflict could have second-order effects on inflation and in such uncertain times, it was important to be nimble and agile, maintaining a broad policy stance.

Even before the fuel prices were increased, the wholesale price inflation surged to 8.3% in April, the highest in three-and-a-half years. In the coming months, retail inflation is expected to rise too. The looming threat of the El Niño weather conditions, which may affect monsoon this year, could matters worse as food prices may also shoot up if rainfall is deficient and temperatures soar.

Add to that the continuing depreciation of the rupee against the US dollar due to the geopolitical uncertainties and heavy equity market selling by foreign investors, and the RBI will have little choice but to raise rates, experts say. The rupee ended at a record closing low of 96.35 against the dollar on May 18.  

The MPC may still choose to continue its pause in the upcoming meeting in June, but it may be forced to raise rates in subsequent meetings.

How high can rates go?

“The RBI is likely to stay on pause in June. However, from the subsequent policy meetings, we could see rate action. We expect around 75 basis points of rate hikes during the current financial year,” noted Devang Shah, Head–Fixed Income at Axis Mutual Fund. So, by March 2027, the repo rate could move closer to 6% from the current 5.25%.

“If rates are not hiked, the currency will come under pressure, potentially leading to a vicious cycle. Moreover, if CPI inflation rises to 5.5% in the second half of the financial year, maintaining rates at 5.25% would be untenable,” Shah stressed.

Seshadri Sen, Head of Research and Strategist at Emkay Global Financial Services, sees two scenarios from a rate hike perspective. “If the energy crisis subsides, then there will probably be a 25-bps hike to address the immediate short-term risk, beyond that there will be none. However, if the energy crisis continues, it could be as much as 100 bps,” he said.

Dhananjay Sinha, the Co-Head of Institutional Equities at Systematix, wrote after last week’s fuel price hike that it would mark the beginning of a series of hikes. The initial adjustment covered only 7-8% of the cumulative under-recoveries from three months of selling fuel at unchanged prices, a burden he estimated at Rs 1.7-1.8 lakh crore. With crude potentially remaining anchored above $100 per barrel, WPI inflation crossing 10% was a “plausible and near-term base case,” he said.

“While the central bank may initially look through the near-term surge in inflation, its persistence, compounded by a weakening currency, could eventually force a reversal of policy rates. That would mark a painful unwinding of the aggressively accommodative stance adopted last year, one delivered through a profusion of liquidity measures, steep rate cuts, and a significant easing of regulatory guardrails for lenders,” Sinha said.

Puneet Pal, Head of Fixed Income at PGIM India Mutual Fund, sees the RBI raising policy rates by 50-75 bps by the end of December. The bond markets are already factoring in the rise, he said.

“Given the lingering geopolitical issues, constraining the central government’s fiscal position and with the state’s fiscal deficit expected to remain elevated, the supply-demand dynamics remain unfavourable, and we expect yields to keep trending higher gradually,” noted Pal.