Petrol pain: How fuel price hike complicates RBI’s inflation fight

Almost three months after the start of the US-Iran war, the economic fallout from the Middle East is beginning to hit home. Finance Minister Nirmala Sitharaman has expressed concern on 3Fs: fuel, fertilisers and forex.The biggest proof of the impact lies in the recent series of petrol, diesel, and CNG price hikes. Over a period of 11 days, starting May 15, petrol prices have been increased by Rs 7.38/litre and diesel prices by Rs 7.48/litre with some inter-city variation.Fuel price hikes impact the common man through several channels, leading to lower disposable income in hand, higher cost of travel, essential and non-essential items. The hikes also make economic decisions difficult for the government and the Reserve Bank of India. Inflation-growth dynamics start impacting policy making both at the fiscal and monetary level.

Impact of petrol, diesel price hike: How it feeds into your budget & economy

Every Re 1 hike in petrol, diesel, CNG, and LPG costs feeds into inflationary pressures in the economy, and also indirectly impacts discretionary spending, hence hitting growth channels. The impact works in two ways: First is the direct spend of households on fuel-related spending. The second is the increase in transportation costs depending on the fare and freight increases. Because diesel powers a large part of India’s transportation and logistics network, higher prices immediately raise the expense of moving goods such as vegetables, milk, cement, steel, and consumer products. Freight rates climb, trucking becomes costlier, and businesses often transfer these higher costs to consumers through increased retail prices.Petrol hikes also strain household finances – they make the daily commuting more expensive, while higher CNG prices make operating costs for taxis, autos, buses, and urban transport systems more expensive.

This impact of fuel prices can then gradually spread across sectors, lifting the prices of both essential and non-essential goods and adding to overall inflation. Elevated fuel prices can also hurt economic growth by reducing consumer spending power and increasing costs for businesses, forcing some companies to delay investments or expansion plans. At the same time, persistent fuel inflation makes monetary policy more difficult for the Reserve Bank of India, as it limits the room for interest rate cuts even during periods of slowing growth. Higher fuel import bills also widen the current account deficit, weaken the rupee, put pressure on foreign exchange reserves, and increase subsidy-related stress on government finances, creating challenges across the broader economy.DK Srivastava, Chief Policy Advisor, EY India explains how the cascading effect works:

How much inflation spike is coming?

The extent of the impact of rising fuel prices on rupee is difficult to quantify, feel experts, since the effect can sometimes be disproportionately high.DK Srivastava tells TOI, “It is difficult to estimate the quantitative impact since the price hikes are staggered. Impact on inflation would also depend on demand reducing effect of petroleum price increases. We expect that after an overall increase averaging about Rs 7.5/litre in petroleum products, CPI inflation may go up by about 75 basis points. In May 2026 CPI inflation may thus be in the range of 4-4.5% and June CPI may be in the range of 4.5-5%.”For Ranen Banerjee, back of the envelope computation impact would be around 10 basis points if the increase in freight and fares are proportionate. “However, we have seen the freight and fare increases being higher than the percentage increase in diesel and petrol rates. Hence, the exact impact of the inflation will be dependent on the extent of fare and freight increases by the transporters,” he says.Vivek Kumar, Economist at QuantEco analyses that petrol and Diesel have a weight of 4.5% and 0.3% in the CPI, respectively. “Considering that the average price of petrol and diesel across the four metro cities is currently at Rs 108.65 and Rs 98.10 respectively per litre, an incremental hike by Re 1 in both Petrol and Diesel will add approximately 5 basis points to CPI inflation,” he says.

Making RBI math tough

Six months ago, the RBI was talking about a Goldilocks scenario of high growth and low inflation. But now, it faces a big test. With inflation expected to rise to higher levels in the coming months and growth likely to slow if the conflict continues, the central bank is staring at a completely opposite situation: higher inflation and lower growth.RBI’s next monetary policy decision is scheduled for June 5, 2026. Will it hike the repo rate in a bid to control rising inflation and control a falling rupee. A repo rate hike makes borrowing less lucrative, hence reducing flow of money. Similarly, a hike in repo rate raises interest rates on bonds making them attractive for foreign investors, which in turn strengthens the rupee. But a rate hike also negatively impacts growth triggers in the economy, hence impacting GDP growth – hence making the decision a tough call for the central bank. Experts believe that for now a rate hike seems unlikely, though the RBI will be in a wait-and-watch mode. The added threat of El Nino, which may disrupt normal monsoon, is expected to add to inflationary pressures.Ranen Banerjee of PwC doesn’t see an immediate case for a repo rate hike. “The MPC does inflation targeting and the CPI currently is well below the 6% upper band. We expect a continued pause in the next MPC meeting,” he says. “If global crude prices remain high for a longer period with inflation going beyond its targeted band, the MPC may be forced to do a rate increase,” he adds.Vivek Kumar of QuantEco expects a rate hike cycle to start later in the year. This is due to the emerging likelihood of deficient rainfall this year and the impending fiscal impulse via 8th Pay Commission payouts next year. “We believe the MPC could start the rate hike cycle in H2 FY27,” he tells TOI.

Fiscal, not monetary policy intervention?

Importantly economists question the efficacy of rate hike as a long-term measure to attract inflows and stabilise the rupee.At present almost 100% of India’s inflation problem would be due to costlier imports of crude, which translates into a hike in the price of Indian crude basket. Since this is a cost-push inflation, hence the monetary policy may not be very effective in controlling inflation. DK Srivastava of EY India says, “We do not expect a rate hike in June 2026. Since the increase in CPI is cost driven, adjustments in repo rate may have limited effect in containing inflation. RBI may like to wait until the fuel price hike settles down and examine its impact over a quarter before taking a decision.”“If CPI inflation crosses the level of 5% and shows upward momentum, RBI may start tightening interest rates,” he adds.Ranen Banerjee says that the action and onus under such a scenario will shift more to the fiscal policy side and the government would have to bear higher fiscal deficits and increase budgetary spends to pump prime the growth to avoid a scenario of stagflation.“There is a significant impact on inflation from higher crude prices. The WPI increases by almost 60 -70 bps for every $10 per barrel crude price increase. The CPI increases come with a lag depending on extent and timing of cost pass throughs by producers. The monetary policy can only support through liquidity support under such situations. If the prices become too high, then a rate action would come into play,” he explains.

Stress tests for India

The Indian economy is facing several stress tests at the same time: crude oil prices are rising leading to fuel price hike, rupee is falling, foreign investors are exiting, trade deficit is widening, forex reserves are falling. But, even as economists highlight these risks, they also express faith in India’s economic fundamentals and resilience. It is these very factors that have helped India tide over the current crisis till now.

DK Srivastava of EY India cautions: If global crude prices remain elevated for a prolonged period, that is, three to four quarters in 2026-27, CPI inflation may increase to about 6% and real GDP growth may fall below 6.5%.The biggest factors that will now determine how well India emerges from this external sector shock will be the length of the conflict, prices of global crude oil prices, the RBI and government’s steps to attract foreign inflows, stabilise the rupee, cushion citizens from higher prices, while at the same time not straining finances too much.