As RBI rate hike looms, action beyond 25 bps a minor possibility

The RBI last increased the repo rate way back in February 2023. As such, any rate hike on Wednesday will be the first in over three-and-a-half years. (Source: File)

The Reserve Bank of India’s (RBI’s) Monetary Policy Committee (MPC) began its three-day meeting on Monday. And while most economists are predicting that a 25-basis-point (bps) increase in the policy repo rate to 5.5% will be announced on Wednesday, talk has emerged that a larger hike could be possible.

“It’s not a debate that there will be a rate hike on Wednesday. But considering the MPC is now acting from behind the curve, it could even be a 50 bps increase,” said a senior economist who did not wish to be named.

While the six-member MPC had unanimously left the repo rate unchanged at 5.25% on August 5 and offered rather sanguine commentary to go along with it, minutes of its meeting, released two weeks later, struck a different note. Governor Sanjay Malhotra, for instance, said that while the headline retail inflation had averaged only 2% in 2025-26 — when the repo rate was brought down to 5.25% — there were signs it was now normalising. This “may suggest a recalibration of policy rate.”

Meanwhile, Deputy Governor Poonam Gupta noted “a case for a hike may emerge during the course of the year”.

According to Soumya Kanti Ghosh, State Bank of India’s Group Chief Economic Advisor, the RBI may “raise rates by 25 bps AT LEAST” (emphasis Ghosh’s).

Madhavi Arora and Harshal Patel of Emkay Global Financial Services said that “a 50 bps hike cannot be ruled out as a potential policy catch-up”.

The RBI last increased the repo rate way back in February 2023. As such, any rate hike on Wednesday will be the first in over three-and-a-half years.

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The headline inflation rate, based on the Consumer Price Index (CPI), rose to 4.82% in August, as per latest data. While this is comfortably within the RBI’s mandated range of 2-6%, it was the third month in a row that it had come in above the medium-term target of 4%. The RBI’s most recent forecasts also show inflation rising to an average of 5.9% in the last three months of 2026, before cooling to 5.5% and 5.3% in the first two quarters of 2027.

Long rate hike cycle?

To be sure, the market overwhelmingly expects the repo rate to be raised by only 25 bps on Wednesday. However, many who do so have not only brought forward their prediction of a rate hike from December to October but also think the RBI may end up raising interest rates significantly.

Morgan Stanley economists led by Upasana Chachra see the RBI on Wednesday kicking off a run of four consecutive rate hikes of 25 bps each, or 100 bps in total, which will take the repo rate to 6.25% in April.

“We view the rate hike cycle primarily as policy normalisation rather than disruptive tightening,” Morgan Stanley said in a report last week.

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The word ‘normalisation’ has found several takers, with some even suggesting the first 50 bps of increase in interest rate will only lead to some normalisation of monetary conditions.

The last time the repo rate was 5.25% or lower was in mid-2022, when the RBI was in the middle of reversing the extraordinary measures taken to help the economy hit by the coronavirus pandemic.

Barclays’ Rahul Bajoria and Smriti Mehra have not only brought forward their rate hike call of 25 bps to this week from December but also doubled their prediction of total tightening to 100 bps from 50 bps. According to them, the balance of risks is shifting away from accommodation to tightening.

“This essentially is no longer just about reversing the incremental cut that the RBI had delivered last December but actually taking away the monetary punchbowl before inflation risks become entrenched amid a large inflow of liquidity.”

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Upside risks mounting

While CPI inflation is well within the 2-6% mandated range, there are signs that price pressures are rising: as many as 314 of the 358 items in the CPI basket saw higher prices in August compared to July. The number was 310 in July and 236 in February, before the West Asia war had begun.

Inflation is being driven by a variety of forces: higher energy prices due to the West Asia conflict, sub-par monsoons pushing up food prices, skyrocketing ‘chipflation’ making consumer electronics more expensive, and a low base until April 2027 or so. With growth stronger than expected, demand may impart a push to inflation too.

The availability of money in the banking system — or, liquidity — is also very high due to the $133 billion of foreign inflows that have come in via the highly attractive Foreign Currency Non-Resident (Bank) deposit scheme. These inflows, according to Sajjid Chinoy, Head-Asia Economic Research at JPMorgan, have created a “liquidity overhang which has meant that monetary conditions are actually more accommodative than interest rate levels would suggest,” he told Bloomberg Television.

While the liquidity deluge has lowered the weighted average call rate — interest rate at which banks borrow from each other — from August onwards, the central bank has pushed it up since the second half of September through a variety of instruments, including the sale of government bonds.

Siddharth Upasani is a Deputy Associate Editor with The Indian Express. He reports primarily on data and the economy, looking for trends and changes in the former which paint a picture of the latter. Before The Indian Express, he worked at Moneycontrol and financial newswire Informist (previously called Cogencis). Outside of work, sports, fantasy football, and graphic novels keep him busy.   ... Read More