RBI May Raise Repo Rate to 5.5%

• RBI expected to raise repo rate by 25 basis points.
• Repo rate could rise to 5.50% on Wednesday.
• Rupee nears record low as oil crosses $100.
• RBI faces inflation and excess liquidity pressures.

GG News Bureau
Mumbai, 6th Oct: The Reserve Bank of India (RBI) is expected to raise interest rates for the first time in nearly four years on Wednesday, as accelerating inflation, a weakening rupee and renewed pressure from crude oil prices prompt policymakers to shift towards tighter monetary conditions.

A quarter-point increase would take the benchmark repo rate to 5.50% and mark the first rate hike under Governor Sanjay Malhotra, who took charge in December 2024 after overseeing a series of rate cuts last year.

According to a Bloomberg survey of 41 economists, 35 expect the six-member Monetary Policy Committee (MPC) to raise the repo rate by 25 basis points, while the remaining economists expect the central bank to leave rates unchanged. The MPC is also expected to retain a neutral policy stance, leaving room for further action depending on economic conditions.
Inflation, oil and rupee under pressure

Since the RBI’s August policy meeting, inflation has accelerated, crude oil prices have risen above $100 a barrel, the US Federal Reserve has begun tightening policy and the rupee has weakened.

Foreign exchange reserves also recorded a sharp weekly decline as the RBI intervened to support the domestic currency.

With inflation approaching 5% and expected to move closer to the upper end of the RBI’s 2%-6% tolerance band during the December quarter, economists see scope for additional rate increases beyond Wednesday.

The relatively resilient domestic economy, meanwhile, could provide policymakers some room to raise borrowing costs without significantly affecting growth.

Gaura Sen Gupta, chief economist at IDFC First Bank, expects a “shallow” rate-hike cycle totalling 75 basis points by February, primarily to prevent the real policy rate from turning negative as inflation rises.

She said a shift in the policy stance could signal a deeper tightening cycle, which she considers unwarranted because inflation remains largely supply-driven while growth faces risks in both directions.

Middle East conflict adds to inflation risks
The escalation of conflict in the Middle East has pushed crude oil prices above $100 a barrel, raising concerns about higher costs across India’s import-dependent energy economy.

India’s weakest monsoon in more than a decade could also add pressure to food prices. Minutes of the RBI’s previous policy meeting showed that policymakers were already concerned that persistent inflation could require action.

Governor Sanjay Malhotra is scheduled to announce the policy decision at 10 am in Mumbai.
Beyond the rate decision, markets will closely watch the RBI’s guidance on the pace and size of any further increases and whether inflationary pressures are becoming broader across the economy.

Citigroup economist Samiran Chakraborty expects the RBI to raise its inflation projection by around 10 basis points from 5% while upgrading its growth forecast from 6.7% for the financial year ending March 2027.

Rupee, bond yields and liquidity in focus
The rupee was trading near a record low at 96.3837 per US dollar on Tuesday. Meanwhile, the benchmark 10-year government bond yield stood near a 2.5-year high of 7.23%, having risen by nearly 30 basis points since September.

VRC Reddy, head of treasury at Karur Vysya Bank, expects the yield to remain around that level if the RBI delivers the expected 25-basis-point hike while retaining a neutral stance.
He said a more hawkish approach towards rates and liquidity could push the yield towards 7.38%-7.40% in the coming months.

However, not all economists see an immediate need for higher rates. Alexandra Hermann Prasad of Oxford Economics has argued that core inflation, excluding volatile food and fuel components, remains benign and gives the RBI room to continue supporting growth.

Foreign outflows add to pressure
The policy decision comes as foreign investors have withdrawn a record amount from Indian equities this year, amid elevated US yields, high oil prices and a weaker rupee.

The NSE Nifty 50 has declined for eight consecutive weeks, its longest losing streak in 25 years.

The RBI is also dealing with a large pool of excess liquidity that has kept overnight borrowing costs below the policy rate and made financial conditions easier than intended.

Much of the surplus followed the RBI’s June initiative to attract foreign-currency deposits to support the weakening rupee. The move brought in around $133 billion, significantly above initial expectations of $50 billion-$85 billion.

The inflows strengthened India’s external buffers but also injected substantial liquidity into the banking system as inflationary pressures increased.

The central bank has already absorbed more than ₹1 trillion ($10.4 billion) through bond sales and other measures.

Markets will therefore watch Malhotra’s comments for indications of how aggressively the RBI intends to absorb the remaining surplus alongside any increase in borrowing costs.

Economists at Barclays, led by Aastha Gudwani, expect the RBI to continue absorbing liquidity through open market operations and currency swaps. A cash reserve ratio increase remains an option, although they consider it less likely because of the permanent nature of the tool.