Monsoon Risk: 10% Rain Deficit Could Shift RBI Rates

Crude cools, weather takes centre stage

Crude prices have eased after the West Asia truce, changing what economists see as the key near-term driver of India’s inflation path. The recent run-up in global energy costs had pushed up domestic prices of petrol, diesel, LPG and other fuels, adding to inflationary pressure. But with oil now cooling, attention is shifting to the southwest monsoon and what it could mean for food prices. Several economists in the report said rainfall is emerging as a larger swing factor for inflation than crude oil in the coming months. The concern is straightforward: weak rains can hit crop output, tighten food supply, and push up food inflation. That, in turn, can influence how long the Reserve Bank of India (RBI) keeps rates steady, and whether it needs to pivot later in the year.

Nomura’s Sonal Varma: food inflation could offset oil gains

Sonal Varma, Chief Economist at Nomura, said in a Bloomberg segment that India’s outlook increasingly depends on whether the monsoon delivers enough rainfall to support food production. Varma argued that if rainfall disappoints, a new wave of food inflation could offset many of the economic benefits created by lower oil prices. She noted that India’s core inflation, excluding precious metals, is running about 2% to 2.5%, indicating underlying price pressures remain contained. The bigger emerging risk, she said, is a below-normal monsoon and a high likelihood that food-production output growth contracts. Nomura also sees a real possibility that the rainfall shortfall exceeds the roughly 10% currently projected by forecasters. If that happens, food-production shortfalls could accelerate food inflation in the second half, squeeze rural demand, and complicate the RBI’s steady-hand stance.

Two competing forces shaping the RBI’s room to manoeuvre

Varma’s view rests on two countervailing forces. On one side, lower oil prices have strengthened India’s external accounts, supported the rupee by boosting foreign-exchange reserves, reduced inflation pressure, and given the RBI more space to keep interest rates steady. On the other side, a weaker monsoon could quickly change the inflation mix by lifting food prices. Economists warned that if rainfall falls well short of forecasts, food production could weaken and rural demand could come under pressure. That combination can also feed back into broader consumption trends. The key policy implication highlighted in the report is that a weather-driven food shock can be harder to ignore if it threatens to push headline inflation towards the upper end of the RBI’s tolerance band.

Government view: external pressures easing, monsoon still a risk

In its latest monthly review, the Finance Ministry said easing crude prices and improving global supply chains should soften external pressures on India. At the same time, it cautioned that geopolitical uncertainty and an uneven monsoon remain key risks. This framing reflects a shift from imported inflation risks to more domestic supply-side risks. The ministry’s message is that external conditions look better than they did during the oil spike, but the inflation and growth outlook still has vulnerabilities. In practical terms, that keeps food prices, rural incomes, and agriculture-linked demand under closer watch over the next few months.

RBI Governor’s signal: too early to talk about hikes

RBI Governor Sanjay Malhotra said on June 24 it was premature to talk about raising interest rates. The comment signalled that policymakers would prefer to assess how oil prices, the monsoon, and global conditions evolve before changing course. This aligns with the idea that the next move in rates may depend on how much food inflation adds to headline prints. The article also notes the RBI is closely monitoring the weather to assess the inflation outlook and stands ready to respond if price pressures broaden. The practical timing issue is that the inflation picture can become clearer only after the critical monsoon months, particularly July and August.

What banks and economists are changing in their forecasts

DBS has removed its forecast of a rate hike this financial year, arguing that lower energy prices have substantially reduced one of the biggest upside risks to inflation. DBS also said it sees downside to its end-year forecast for the 10-year yield, which it puts at 6.9%. Another bank retained its inflation forecast at 4.9% but said July and August rainfall would determine the outlook for food prices because those two months account for more than two-thirds of the southwest monsoon. This underscores how the market’s inflation narrative is splitting into two layers: energy easing helps, but food remains the wild card. Importantly, the report also notes that most economists do not expect the RBI to react immediately, with rate-hike discussions likely deferred until after October when there is more clarity on output, food prices, and the broader trajectory.

Quantifying the monsoon risk: inflation and the RBI’s tolerance band

QuantEco Research economist Yuvika Singhal estimated that a 10% rain deficit could add as much as one percentage point to headline consumer inflation, driven by food prices. Madan Sabnavis expects headline inflation to top 5.5% by October, near the upper end of the RBI’s tolerance band, on food-price pressure. If that plays out, it could force the RBI to hike rates, which would be the first increase since February 2023. Dr Manoranjan Sharma, Chief Economist at Infomerics Ratings, also said the bigger inflation risk for India today is no longer crude oil but rainfall. Separately, Senior economist Mitali Nikore described a weak monsoon as India’s second supply-side shock of 2026 after crude oil, and the more structural of the two. The common thread across these views is that weather-linked food inflation can influence both policy rates and expectations for borrowing costs.

Why El Nino matters: a structural supply-side shock

Economists warned that a developing El Nino could curb rainfall and lift food prices, reinforcing the monsoon risk. This is being treated as more than a one-off market event because rainfall patterns directly affect sowing, yields, and farm incomes. The report also links the risk to rural demand, noting that food-production shortfalls could squeeze rural consumption. If borrowing costs stay elevated due to constrained room for rate cuts, that can add pressure to demand conditions. The point made in the accompanying commentary is that a weak monsoon could restrict the RBI’s ability to cut interest rates further, keeping financing costs higher for longer.

Key numbers and policy markers

Market impact and what to watch next

The market impact described in the report is less about immediate policy action and more about what could change inflation expectations into the second half. Lower crude prices reduce one major upside risk to inflation and support the external balance, which can be positive for the rupee and reserves, as Nomura highlighted. But the monsoon risk can work in the opposite direction by pushing food inflation higher and weakening rural demand. For fixed income, the direction of yields can depend on whether the RBI is forced to hold rates higher for longer or consider a hike if inflation pushes towards the top of its tolerance band. For households and businesses, the key channel is borrowing costs: a constrained ability to cut rates can keep financing costs elevated. The next clear data points, as outlined in the report, are rainfall outcomes in July and August and subsequent signs of stress in food prices and rural demand.

Conclusion

With crude prices easing after the West Asia truce, economists say India’s inflation risk is increasingly concentrated in the monsoon. Forecasts and policy guidance now hinge on whether rainfall stays near expectations or deteriorates enough to lift food inflation meaningfully. RBI Governor Sanjay Malhotra has signalled it is premature to talk about hikes, and many economists expect any rate-hike discussion to wait until after October, when there is more clarity on crop output and food prices. Until then, markets are likely to track July and August rainfall closely, given their outsized share of the monsoon and their influence on the inflation outlook.