Top economists expect the Reserve Bank of India to raise the repo rate by 25 basis points on October 7. Experts said global bond yields, the rupee, and inflation risks will influence future moves. Sonal Varma noted, "We are not seeing second-round effects," as the central bank weighs its next steps.
Top economists expect 25-bps RBI rate hike, see risks from global yields, rupee and inflation
Top economists assess the RBI's policy options as global bond yields rise, with views divided on inflation risks, financial stability, capital flows and growth in the months ahead.
By Latha Venkatesh
Leading economists, including Sajjid Chinoy, Head-Asia Economic Research at JPMorgan, Soumya Kanti Ghosh, Group Chief Economic Advisor at State Bank of India (SBI), Sonal Varma, Managing Director & Chief Economist-India and Asia Ex-Japan at Nomura Financial Advisory & Securities (India) Private Limited, Pronab Sen, Economist & Former Chief Statistician and Samiran Chakraborty, Chief Economist at Citi India, expect the Reserve Bank of India (RBI) to raise the repo rate by 25 basis points on October 7. However, their views point to a more uncertain path ahead, with global bond yields, the rupee and inflation pressures likely to influence the central bank’s next moves.
While Varma sees no clear evidence of second-round inflation effects, Chinoy points to strong global growth and rising commodity prices as risks. Ghosh expects near-term growth forecasts to improve but sees challenges ahead, while Chakraborty flags financial stability and capital flows as reasons for the RBI to potentially adopt a more aggressive stance. Sen, meanwhile, favours a phased approach to rate hikes.
This is an edited transcript of the interview.
Q: The Governor, in the minutes as well as earlier, indicated that they will look for second-round impact of the crude price rise and other triggers. Do you think there is enough evidence for the Governor to build on it and force a hike? Are you seeing second-round impact?
Sonal Varma: I think specifically in terms of second-round effects, the answer is no. We are not seeing second-round effects, and we've looked at multiple ways to assess the second-round effect.
One is diffusion measures. So, what percent of the consumer price index (CPI) basket is rising above 4%, both on a weighted and an unweighted basket basis? That number is between 30% to 36%, so still below the 50% threshold.
Measures of underlying inflation, like trim mean, remain less than 4%. Inflation expectations of businesses have moved up, reflecting the higher input costs. But households' expectation, which is the last survey we had, remained consistent with inflation of around 5%, and wage dynamics, both at rural and urban level, don’t suggest any round of second-round effects.
So, what we are seeing in effect, is one, the momentum measures have picked up, and second, business expectations have picked up because of higher input costs. But in terms of generalisation, that evidence, I don't think, has been seen, and that has been a big surprise, I must say, seven months into the Iran war.
Q: The rise and rise of US yields, 24-year highs, and similar highs. Whether you look at Great Britain or Japan or other European countries, isn't that a big pressure on the Monetary Policy Committee (MPC) to hike?
Sajjid Chinoy: One has to understand why that's rising. And, in a way, what you're seeing is reals across the world are reflecting very strong, broad-based growth.
Higher yields are not reflecting inflation expectations going up; they're reflecting the fact that real rates have gone up because of the strength of growth.
Through all the talk this year about the oil shock and geopolitics and higher US rates, the fact is, the global economy for three straight quarters has grown a half a percent above potential. So, we're growing above potential.
The September Purchasing Managers' Index (PMIs) were the highest in five years. So, there's no let-up in global growth. And what you're seeing now is a broadening. This was driven largely by tech in Asia in the early months of the year. Now this has broadened out to non-tech.
So, I think we have to live with the fact that global growth is extremely strong, and you've got inflation pressures that are building as well. Crude prices remain still very elevated for longer than we had expected. Commodity prices around the world have increased. The risk of an El Nino has picked up. That'll hurt growth, but it's going to push up food inflation pressures.
So, what you're seeing is a global backdrop where stronger growth and inflation pressures are rising. But there is a tension. This is not a one-way street.
The tension we saw on Friday, October 2, which is that despite above-trend growth, this is not translating yet into labour market tightness. We're not seeing employment pick up at the pace that you would have expected. Your wage growth has moderated.
So, with that tension, the sense is that central banks will be walking, not running. We still expect seven of the nine developed market central banks we track to raise rates in this quarter, but perhaps not at the pace that markets had feared, because labour markets are not tightening.
But that said, the fact that growth is so strong, central banks will have to be tightening. And fiscal policy, which doesn't get discussed enough, has been irresponsibly pro-cyclical in many developed markets, has contributed to very sticky long-end yields.
So, this is not a particularly favourable backdrop for emerging markets. Yes, you benefit from the growth. India's exports have picked up very sharply because the non-tech sector is picking up. But you also have headwinds from higher global commodity prices, higher crude prices, and El Nino, as well as higher US yields.
Q: Is the rupee not a very big reason why the Reserve Bank may have to move aggressively? A 25-bps hike, I think, is already in the price. It may even be seen as dovish if that is the only thing the RBI gives. So, do you think, at least for the sake of the rupee, they have to sound more than just a 25-bps hike?
Samiran Chakraborty: Typically, the way, after the flexible inflation-targeting framework has been instituted in India, the nominal anchor for the economy has been set as the inflation rate, and that's how the policy rate revolves around it. And this has worked well for us over the last more than a decade.
However, if the MPC considers that at the back end the financial stability argument is also there, this is not explicitly set up in the inflation-targeting framework. But even more recently, the RBI Governor has commented on this, that financial stability is extremely important, and something has changed.
As Chinoy was mentioning, global bond yields have gone up across the board. We might debate whether this is because of higher growth or because of higher inflation or term premia coming out of fiscal pressures. But fact of life is that global bond yields have significantly gone up.
So, in that context, if RBI thinks that it's important to send a signal that it is prepared to join that game, and this is important because historically, India used to get more growth-rate-differential-led capital inflows. It was almost double that of interest-rate-sensitive capital inflows, and that's where we typically used to ignore the interest-rate differential argument.
RBI has never, that's why, followed the Fed one-for-one. But at this current juncture, the growth-rate-differential-sensitive capital flows are not coming as much.
So, we might have a need to track the interest-rate-differential capital flows, encourage them a little bit more, and that could create an environment for a slightly steeper rate hike, also which is different from the standard that we have followed in the past.
It is not our baseline scenario, but I think this is a risk scenario that markets would be considering.
Q: What will the Reserve Bank say about its growth forecast? The April-June quarter of 2026 (Q1FY27) was excellent, 7.8% compared to Reserve Bank's forecast of 7%. Do you think the Reserve Bank can therefore be confident and be as hawkish as it needs to be, or do you think it is a tale of two halves? The second-half growth maybe weaker because of high base, El Nino, crude pressures accumulating. What do you expect to hear about growth?
Soumya Kanti Ghosh: On the growth front there are a couple of challenges and it's very delicately poised.
Chinoy mentioned at the beginning that overall growth across developed economies has been strong, but I think there is now an unpalpable fear of the bond yields going out of control. So that's going to impact the financial markets, mostly in the developed economies, including India.
The second point we need to understand is that the growth numbers are already behind us. So, the RBI may hike the growth forecast for this fiscal, 2026-27 (FY27), maybe by around 20 to 30 basis points, just to get in line with whatever has happened in the first-quarter data, and also the July-September quarter of 2026 (Q2FY27) data looks to be encouraging.
But my concern is a little bit for the forward end of this year. My sense is that because of the El Nino condition, which is getting even stronger, and if you look into the rainfall patterns in states which produce cereals, which produce pulses, it has been significantly on the higher side.
For example, Maharashtra has now declared drought in around 75% of the districts.
The second-half growth numbers could be a challenging one because you have to delicately balance an external environment, which could turn volatile at some point of time, given the way the markets have behaved.
Even the Fed behaviour has been expanding their balance sheet, hiking the rates, but at the same time requesting for a credit card from political circles. So, all this seems to be incongruous. So, that, I think, is one of the reasons why the RBI Governor has recently mentioned about the financial stability part.
Any hike which the central bank will have to do will also take into consideration that part. And my sense is that the window for a rate hike for the central bank or the RBI may not be for a longer period.
So, from that perspective, the Reserve Bank can think of or discuss having an aggressive rate hike cycle in a couple of periods and then go to the normal base.
Q: The RBI's own forecast is showing that inflation is going to average 5.4% or even more over the next 12 months. I mean, it's going to be six in several, maybe more than two quarters, which means we are going to have negative real rates for a whole year if we stick to five quarters. So, is there a case for a double hike, a 50-bps rate hike?
Pronab Sen: You do a rate hike early to forestall inflation. What RBI is talking about is that the supply-side shocks that we've already had, and the supply shock that's about to come, which is essentially because of poor monsoons, the rabi crop may get affected.
That's not something that's happened. So, upfront, there's no real crying need to make the correction at one go. Phase it out would be better because we just don't know what's going to happen in the global economy in the next few months, so I would just wait and see.
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Q: So, let me get the first vote from all of you, the first obvious question: What will the MPC do to the repo rate on October 7?
Samiran Chakraborty: A 25-basis-point hike.
Sajjid Chinoy: 25-basis-point hike.
Soumya Kanti Ghosh: 25-basis-point hike.
Sonal Varma: 25-basis-point hike.
Q: This is what the committee is saying. What's your call?
Pronab Sen: I think it would hike, but 25 basis points.