The Reserve Bank of India’s Monetary Policy Committee (MPC) on Wednesday raised the repo rate by 25 basis points to 5.50%, its first rate hike in nearly four years, as rising oil prices amid US-Iran tensions and a weak monsoon threaten to push inflation higher.
The six-member rate panel voted unanimously in favour of the rate hike. The monetary policy stance was changed to "calibrated tightening" from "neutral".
The repo rate was last raised in February 2023, when it was increased by 25 basis points to 6.50%.
Of the 21 economists and bank executives polled by ET, 20 had expected the RBI to raise rates.
The move marks the first rate hike under Governor Sanjay Malhotra, who took office in December 2024 and oversaw a series of rate cuts last year. It also puts the RBI in line with several Asian peers like Bank of Japan and Bank of Korea that have started tightening policy in response to renewed inflation pressures.
The MPC noted that the global context, on account of geopolitical developments, remains challenging, said governor Malhotra.
Since the RBI’s last policy meeting in August, oil prices have surged above $100 a barrel, the rupee has weakened and inflation has accelerated.
With inflation nearing 5% in the last three month and expected to move closer to the upper end of the RBI’s 2%-6% tolerance band in the December quarter, economists expect the central bank to continue tightening.
The RBI's hike acknowledges that cyclical inflation risks are no longer benign, said Radhika Rao, senior economist, DBS Bank, adding that a change in stance also underscored the RBI MPC's "hawkish intent."
"Against a backdrop of elevated oil prices, tighter global conditions, and risks to food inflation from unfavourable weather, policymakers have chosen to reinforce inflation credibility before risks become entrenched."
Crude back above $100 a barrel
Escalating conflict in the Middle East has pushed crude prices above $100 a barrel, threatening to raise costs across an economy that imports most of its energy. A weak monsoon, meanwhile, could add to pressure on food prices.
Brent crossed $101 today. It ended September at around $103, well above the RBI’s FY27 forecast of $85 a barrel. Goldman Sachs has also outlined a scenario in which oil prices could rise to as much as $120 a barrel if attacks on vessels in the Middle East intensify. If exports return to normal, the bank expects oil prices to move back towards $80 a barrel.
The combination of higher crude prices and supply disruptions has added to inflation concerns globally. Domestically, economists see inflation potentially rising above the RBI’s 6% tolerance limit in the third quarter.
The narrowing interest-rate differential between India and the US is another factor weighing on the RBI’s decision. The India-US 10-year yield gap has fallen to 189 basis points, its lowest in decades, with yields at 7.21% and 5.32%, respectively.
A narrower gap can make US assets relatively more attractive to investors and add pressure on the rupee. Rupee fell 10 paise to 96.45 against US dollar in early trade today.
Foreign investors have pulled 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.
Too much cash
The RBI is also dealing with a large pool of excess liquidity that has pushed overnight borrowing costs below the policy rate, making financial conditions easier than intended.
Much of the surplus came from the RBI’s June push to attract foreign-currency deposits to support the rupee. The move brought in about $133 billion, far above initial expectations of $50 billion-85 billion. While the inflows strengthened India’s external buffers, they also injected a large amount of liquidity into the banking system at a time when inflationary pressures were building.
The central bank has already drained more than ₹1 lakh crore ($10.4 billion) through bond sales and other measures, as per Bloomberg.
Traders will now look for signals on how aggressively the RBI plans to absorb the remaining surplus alongside further rate hikes.