A poll of 12 economists by The Times of India has confirmed that most expect the Reserve Bank of India to raise the repo rate by 25 basis points in October, marking the first increase since February 2023. The poll shows that economists expect rates to rise by 50-75 basis points in this financial year, with the majority anticipating a shallow tightening cycle of 50-75 basis points. This consensus follows the Federal Reserve's 25 basis points hike to 3.75%-4% on September 16, which has prompted similar expectations for RBI policy action. Crisil chief economist D K Joshi noted that space is shrinking for monetary policy to remain in wait-and-watch mode, while CareEdge Ratings chief economist Rajani Sinha expects the MPC to take note of rising government bond yields alongside broadening price pressures.
The Reserve Bank of India drained liquidity equivalent to nearly 0.2% of total bank deposits on Thursday through its first open market operation bond selling in nine years, as reported by The Economic Times. The central bank is expected to step up these operations going forward, as a large liquidity surplus in the banking system can blunt monetary-policy transmission by curbing banks' need to borrow at the RBI's policy rate. FCNR(B) inflows have created a core liquidity surplus of nearly ₹15 trillion in the domestic market, according to HSBC's Chief India Economist Pranjul Bhandari. The Foreign Currency Non-Resident Bank scheme has pulled in $127 billion, lifting spot FX reserves, but leaving a domestic liquidity glut. Excess liquidity can quickly become inflationary and can raise financial stability risks if banks become dependent on abundant liquidity. The RBI has already deployed Variable Rate Reverse Repos (VRRRs), Open Market Operation (OMO) Sales, and FX swaps/spot sales to manage the surplus.
Markets are bracing for monetary policy tightening, with expectations of a 25-basis-point repo rate hike by October strengthening after the US Federal Reserve's move. According to Emkay Global, the Reserve Bank of India's rate-setting panel is expected to end its almost year-long easing cycle with a 25-basis-point hike at the 7-October Monetary Policy Committee meeting. Market participants expect the central bank to raise the rate at which it lends short-term funds to banks again in December as the global policy mood turns hawkish. V.R.C. Reddy, treasury head at Karur Vysya Bank Ltd, noted that the global rate backdrop has turned decisively less benign, with the US Fed hiking 25bps and the Bank of Japan moving towards further normalization amid elevated US yields. The India-US 10-year bond yield spread is at approximately 200 bps, which is near multi-decade lows and roughly half of its long-term historical average, reducing the Reserve Bank of India's room to pursue aggressive easing. The Fed's decision will add to calls for the RBI to hike in its October meeting to maintain India's interest rate differential with the US and mitigate any large potential foreign fund outflow.
Economists expect the RBI to consider 50 basis point hikes in both the October and December policy meetings, with the upward climb split equally between the two meetings. According to SBI Research, the retail inflation rate may cross 6.5 percent before falling below 6 percent in early 2027. HSBC economists led by Pranjul Bhandari expect the rate to reach 5.5 percent by September, with forecasts suggesting inflation will remain above 5 percent for about nine months. In August, retail inflation increased to 4.82 percent, marking the tenth consecutive monthly rise and the highest level since December 2024, with wholesale inflation rising more sharply to 9.92 percent in August 2026 from 9.78 percent in July. Food inflation is close to 6 percent, while core inflation has also risen gradually, suggesting price pressures are broadening beyond a few categories. The Price Pinch has intensified with food price inflation jumping to 6% from 5.5% a month prior, led by sugar and vegetables, and core inflation rising to 4.2% from 3.9%. Kotak Mahindra Bank chief economist Upasana Bhardwaj noted that during the second quarter, average inflation will be around 20 bps higher than RBI's estimate of 4.7%. IDFC First Bank chief economist Gaura Sengupta said the probability of rate hike is high in October as inflation is expected to peak in the next quarter, with FY27 retail inflation expected to average 5% with upside risk.
The bond market has already started adjusting to the expected rate hikes, with the 10-year government bond yield trading near 7.05%, close to a four-month high. Vinit Bolinjkar noted that conditions have become less supportive for any cuts, with inflation rising, wholesale prices remaining elevated, bond yields near 7 percent, and the Fed shifting back towards rate increases. Nikunj Saraf, CEO of Choice Wealth, said a 25 bps RBI rate hike is possible but not a certainty, with the key trigger being persistent inflation, particularly if elevated crude prices start feeding into domestic inflation and put pressure on the rupee. Overnight indexed swaps rose on firmer domestic rate hike wagers, with the one-year rate leaping 4 bps to 6.0725%, the two-year rate rising 4 bps to 6.28%, and the five-year rate adding nearly 2 bps to 6.5875% for the week. The benchmark 6.94% 2036 bond yield closed at 7.0686% on Friday, up from 7.0463% on Thursday, taking its weekly rise to 4.5 basis points. Axis Capital expects the overall hiking cycle to be limited to 75 bps, with the RBI's focus likely to remain on draining surplus liquidity and bringing overnight rates back into alignment with the policy rate. For Indian equities, the Fed's tighter policy stance is reducing the Reserve Bank of India's room to pursue aggressive easing, with the India-US 10-year bond yield differential near multi-decade lows constraining domestic policy flexibility.
