The RBI may raise the repo rate by 25 basis points in the October MPC meeting. This modest hike aims to control inflation as the rupee fell 8.1 per cent in 12 months. Foreign investors sold ₹25,662 crore of Indian equities through September 29, adding pressure on the local economy.
The October MPC is less than a week away, and a 25-basis-point increase in the repo rate would not necessarily herald an aggressive tightening cycle. On the contrary, it would serve as an insured move against a broadening inflation which is inching north, and a less benign external environment which is refusing to ease. Hence, a modest increase in October could help the RBI to stay ahead of the inflation curve without materially disrupting growth. Essentially the choice is not between tightening and restraint, but between acting early and being forced to act more forcefully later.
Further, the recent developments in the US have narrowed RBI’s room for delay. The US Fed raised its policy range by 25 basis points to 3.75-4 per cent in September while signalling further tightening this year. US Treasury yield continued to surge, with the 10-year touching 5.26 per cent and 3-year touching 4.98 per cent by September 29, making the dollar attractive and naturally tightening financial conditions for emerging markets.
And hence akin to other emerging markets (EMs), India too will experience a narrower interest-rate differential making the rupee less attractive, leading to continued outflow of capital as is being experienced in the capital market. The rupee, which has fallen by 8.1 per cent in last 12 months, is poised to further amplify the inflationary numbers.
Renewed foreign portfolio outflows have added to external pressures in India. FPIs sold a net ₹25,662 crore of Indian equities through September 29, reversing net purchases of ₹20,200 crore in July and ₹29,630 crore in August. Higher US yields, expensive crude and rupee weakness have reduced the risk-adjusted appeal of Indian assets. A modest repo hike would not be sufficient to reverse these flows, nor should defending a particular exchange-rate level become a monetary-policy objective. Even so, persistent foreign selling could deepen pressure on a falling rupee, making continued neutral stance increasingly difficult to justify.
Crude oil link
In fact, crude oil is the most direct link between geopolitical tensions and India’s inflation outlook, and RBI’s monetary objective. Brent above $100 a barrel threatens to raise the import bill, pressure the rupee and increase transport and industrial input costs. If the shock persists, businesses will increasingly pass higher freight and production costs to consumers, risking a transition from a relative-price shock to broader and more persistent inflation.
Inflation data strengthen the case for preventive action. Headline CPI inflation rose from 4.45 per cent in July to 4.82 per cent in August, its third successive reading above the RBI’s 4 per cent target, although still within the tolerance band. Food inflation increased to 5.95 per cent, while pressures were also visible in select services. With growth retaining momentum, a modest increase now could carry a lower economic cost than a larger response later if price pressures persist and inflation expectations rise.
India’s bond market is already signalling the shift, with the benchmark 10-year government bond yield moving decisively above 7 per cent in September as higher crude prices, rising global yields and the RBI’s open-market bond sales prompted investors to demand a larger risk premium. Meanwhile, surplus banking-system liquidity reflected in the RBI’s absorption operations, generated substantially by rupee injections against FCNR(B) and other inflows through the forex swap window, exceeded ₹10 lakh crore in early September before falling below ₹5 lakh crore by September 22. VRRR auctions, open-market bond sales, tax outflows and seasonal currency demand absorbed much of the excess. Going forward, the RBI may need to calibrate liquidity absorption carefully, keeping overnight rates aligned with the repo rate while avoiding an unduly sharp tightening of credit conditions.
The RBI need not follow the Fed in lockstep, but it can ill afford to disregard a broader tightening bias in global monetary conditions. Given the current situation, procrastinating a possible repo increase may be avoided. Even an October increase would affect demand and inflation only with a lag.
While external benchmark-linked loans may become costlier quickly, the impact on MCLR-linked loans, deposit rates and the wider economy will take more time. Strong competition among banks during the festive season may also keep the immediate rise in lending rates in check.
Waiting until December would push much of the impact further into Q4 2027, by which point persistent oil and currency pressures may be more firmly embedded in domestic inflation. The experience of 2022, when delayed normalisation culminated in an unscheduled rate hike and cumulative tightening of 250 basis points, illustrates the potential cost of delayed policy intervention.
Mazumdar is Senior Economist, and Mondal is Economist, with Exim Bank. Views are personal