After nearly two years of accommodative monetary policy, the Reserve Bank of India (RBI) is on the verge of initiating a withdrawal of policy support, with the Monetary Policy Committee (MPC) anticipated to commence this process during its meeting on October 7.
Analysts widely predict that the RBI will increase the repo rate by 25 basis points (bps) to 5.50%, potentially signaling the start of a more aggressive series of rate hikes. Such an increase would elevate borrowing costs across the economy, affecting interest rates on various loans including personal, home, and auto loans, as well as deposit rates.
The MPC may also adjust its forecasts for GDP growth and inflation, likely revising both upwards compared to previous estimates.
Minutes from the MPC meeting in August had hinted at this potential shift. Since then, new data regarding domestic inflation and growth, alongside a global environment characterized by rising US interest rates, bond yields, and commodity prices, has left the RBI with little choice but to act. Recently, the US Federal Reserve raised its policy rate by 25 bps to a range of 3.75-4%. Additionally, US benchmark yields have surged, increasing by 49 bps to 5.27% and by 25 bps to 7.21% over the past month.
Rajeev Sharan, Head of Research at Brickwork Ratings, commented, “With the RBI having maintained rates through 2026, there is intensifying pressure to implement an increase during the October review. A hike of 25 basis points to 5.50% is a realistic possibility, marking the first adjustment since early 2023.”
Nomura Global Market Research outlined their expectations, stating, “In our baseline scenario, we foresee the RBI increasing rates by 25 bps in both October and December, culminating in a terminal rate of 5.75%. However, there exists a risk of a one-off hike.” Pranjul Bhandari, Chief India Economist at HSBC Global Investment Research, noted, “Market sentiment is aligning around two key themes: the removal of liquidity and anticipated rate hikes by the RBI.”
Conversely, some analysts suggest that the RBI may opt to keep rates steady. “The RBI might choose not to alter rates in October, but it could adjust market expectations. While the policy decision may remain unchanged, the overall communication could become more cautious,” said Sneha Pandey, Fund Manager for Fixed Income at Quantum AMC.
Domestic retail inflation is increasingly becoming widespread, driven by sustained energy prices and rising food costs, with the effects of El Niño disruptions becoming more apparent. In Maharashtra, drought has been declared in approximately 265 of the state’s 358 talukas, affecting nearly 74% of the region. The Union Agriculture Minister has also raised concerns about potential droughts in states such as Karnataka, Telangana, Andhra Pradesh, and Rajasthan.
Lower reservoir levels, weather-related disruptions, and elevated energy prices are contributing to inflationary pressures. Current reservoir levels across India are about 20% lower than last year, which may impact the upcoming rabi crop. The potential for El Niño conditions to persist into 2027 is also a crucial factor to monitor.
Global challenges are further complicating the economic outlook. Ongoing conflicts in West Asia and the Russia-Ukraine war have introduced additional economic uncertainty, while crude oil prices have surpassed $100 a barrel, raising concerns over imported inflation and its repercussions on the nation’s external balance.
CareEdge Ratings anticipates that retail inflation will peak at 6% in the third quarter and average around 5% in FY27. They identify weather-related risks and fluctuating energy prices as significant threats. Retail inflation, recorded at 4.82% in August, is projected to rise to approximately 5.5%, potentially remaining above 5% for nearly three quarters. With wholesale price index (WPI) inflation around 10%, elevated crude oil prices, and the looming threat of a strong El Niño, market participants are increasingly factoring in the likelihood of rate hikes.
As inflation broadens and global interest rates remain high, the situation poses a risk for India if the interest-rate gap with the US continues to narrow. Economists from Bank of America Securities, Rahul Bajoria and Smriti Mehra, noted, “Food inflation is increasingly pervasive, extending beyond typical perishables. The rise in wholesale prices is gradually affecting both agricultural and non-agricultural sectors, creating a significant disparity between consumer price index (CPI) and WPI inflation.”
Should the repo rate increase, both lending and deposit rates are expected to rise in the short term. Loans tied to external benchmarks—especially those linked directly to the repo rate—will reflect this change almost immediately, leading to higher equated monthly installments (EMIs) for borrowers and increasing their repayment obligations.
Interest rates on loans associated with the marginal cost of funds-based lending rate (MCLR) are also projected to increase. Banks have the discretion to adjust MCLR-based lending rates based on their funding costs, liquidity conditions, and deposit acquisition.
On the deposit front, rates are likely to see a modest uptick. However, any significant or sustained increase would hinge on shifts in liquidity and funding conditions that prompt banks to reevaluate deposit pricing.
The anticipated pivot by the RBI toward a rate-hiking cycle coincides with an economic landscape marked by rising inflationary pressures, soaring crude oil prices, tighter global financial conditions, and robust domestic growth. This strategy aims to curb demand and manage inflation expectations but may also dampen consumption and investment if high borrowing costs persist over an extended period.
As for the growth forecast, the Indian economy demonstrated resilience in the first quarter of FY27, achieving a GDP growth rate of 7.8%, surpassing expectations amidst a challenging global environment. Consumption, investment, and strong export performance fueled this momentum, with positive indicators such as GST collections, auto sales, and bank credit remaining robust.
Following the strong growth in Q1, CareEdge Ratings now projects FY27 growth to be around 7.3%, speculating that the RBI may revise its GDP growth projections accordingly.
