The Reserve Bank of India raised its benchmark repo rate by 25 basis points to 5.50% on Wednesday, its first increase since February 2023, and changed its policy stance to "calibrated tightening" from neutral. The six-member Monetary Policy Committee voted unanimously for the rate rise, which ends almost ten months at 5.25% and comes as oil prices lifted by the Iran war, a deficient monsoon and a weak rupee push up inflation in Asia's third-largest economy, Reuters reported.
Two members, Nagesh Kumar and Ram Singh, voted to keep the neutral stance, according to the committee's resolution. The standing deposit facility rate was adjusted to 5.25%, and both the marginal standing facility rate and the Bank Rate to 5.75%.
The committee said inflation and its outlook "are not benign as they were last year" and that "rate cuts are off the table in the near term and policy action ahead can only be a rate hike or a pause." Governor Sanjay Malhotra told a press conference that the new stance is a "milder form of tightening" that is "more data dependent than pre-determined," Reuters reported.
Inflation forecast raised, growth forecast raised more
The central bank lifted its consumer price inflation forecast for the fiscal year ending March 2027 to 5.2% from 5.0%, and its core inflation projection to 4.4% from 4.3%. For the October-December quarter it projects 6.0%, the upper limit of its tolerance band around the 4% target. Growth forecasts moved up by more: the RBI now expects GDP to expand 7.1% this fiscal year, compared with 6.7% before, after the economy grew 7.8% in April-June against the central bank's own 7% forecast, according to Reuters.
| RBI projection, fiscal 2026-27 | Previous | October 7 |
|---|---|---|
| Real GDP growth | 6.7% | 7.1% |
| CPI inflation, full year | 5.0% | 5.2% |
| Core inflation, full year | 4.3% | 4.4% |
| CPI inflation, July-September | 4.7% | 4.9% |
| CPI inflation, October-December | 5.9% | 6.0% |
The committee projected headline inflation at 5.7% for January-March 2027 and 5.6% for April-June, and growth of 7.2%, 6.9% and 6.8% for the three quarters through March. It described the risks to both forecasts as evenly balanced.
Oil, monsoon and the rupee
Consumer prices rose 4.8% in August from a year earlier, up from 4.5% in July, the RBI said, with sugar and onion prices spiking. Reuters noted that it was the third consecutive month above the central bank's 4% medium-term target. Core inflation climbed to 4.2% from 3.9%, and the weighted share of items in the consumer basket rising faster than 4% increased to about 37%, which the RBI cited as an early sign of inflation becoming generalized.
Brent crude futures averaged 22% above July levels and 15% above August levels in September, the central bank said in a footnote to the Governor's statement. The cumulative rainfall deficit stood at 12.6% on September 30, and strong El Niño conditions could affect the winter-sown rabi crop and rural demand, the RBI added.
The rupee closed at 96.78 per dollar, down 43 paise on the day and a five-month low, according to The Hindu BusinessLine. Reuters said the currency was nearing its record low of 96.96, set in May, and that the RBI has regularly sold dollars in the spot market to slow its decline. Malhotra said markets can be "irrational" in the short term and that, by a number of estimates including the real effective exchange rate, the rupee "may be undervalued."
Foreign portfolio investors pulled a net $10.3 billion from Indian markets between April and October 5, the RBI said, while net foreign direct investment rose to $13.8 billion in April-August from $9.6 billion a year earlier. The Federal Reserve raised rates by 25 basis points in September, according to the committee's resolution. The Economic Times put the gap between 10-year government bond yields in India and the United States at about 189 basis points, at roughly 7.21% and 5.32% respectively.
Growth gives the committee room
The RBI said private consumption and fixed investment drove the April-June expansion and that merchandise exports grew at a double-digit pace in July and August. Manufacturing and services purchasing managers' indexes stayed in expansion territory in the July-September quarter, though growth slowed from the previous quarter, it said. Weak spots included non-durable goods and domestic air passenger traffic.
The merchandise trade deficit widened to $58.7 billion in July-August from $55.1 billion a year earlier, driven by imports of electronics and crude oil, the central bank said. Foreign exchange reserves stood at $734.6 billion on October 2, equal to import cover of about 11 months.
Equities slip, liquidity left alone
Indian equities closed lower. The BSE Sensex fell 429.11 points, or 0.59%, to 72,638.70, and the NSE Nifty 50 lost 173.05 points, or 0.76%, to 22,603.05, HDFC Sky reported. State-owned lenders held up, with the Nifty PSU Bank index up 0.92%, while the Nifty Realty index fell 1.85% and the Nifty Metal index 2.31%, according to Asian News International. The 10-year government bond yield was slightly higher at 7.2269% shortly after the announcement, Reuters reported.
Contrary to market expectations, the RBI did not raise the reserve ratio to drain surplus liquidity, and Malhotra called such a step the "least preferred" option, according to Reuters. System liquidity averaged a daily surplus of 5.9 trillion rupees, or about $61 billion, since the August meeting, the RBI said. Reuters reported that schemes to attract dollars had drawn close to $144 billion as of mid-September, which pushed surplus liquidity to a record 11.16 trillion rupees at the start of September.
Alongside the rate decision, the RBI said it would allow interoperability among account aggregators licensed as non-bank financial companies and let depositories regulated by the Securities and Exchange Board of India include deposit-account details in consolidated account statements, with both measures due by December 31. It also plans a Technical Consultative Committee for Financial Markets.
How far the cycle could run
Economists are divided on the size of the tightening cycle. "We expect another 50-75 basis points in rate hikes over the coming months," Sakshi Gupta, an economist at HDFC Bank, told Reuters. Krishna Bhimavarapu of State Street Investment Management said his base case is for 100 basis points of cumulative tightening in this cycle, while Deepak Agrawal, chief investment officer for debt at Kotak Mahindra Asset Management, said he expects a further 25-basis-point increase in December, as quoted by The Financial Express.
Sumit Singhania, head of research at Bajaj Broking, pointed to core inflation excluding precious metals of just 2.9% in August and said that if price pressures do not broaden, the RBI would do best to pause at 5.50% in December, though a further Fed hike could test that call, The Financial Express reported. Before the decision, swap markets were pricing about 100 basis points of increases over the next 12 months, Reuters reported on Monday.
The committee's minutes are due on October 21, and its next meeting is scheduled for December 2-4.