RBI Rate Decision: India Heads Into Crucial Policy Meet With First Hike in Nearly Four Years on the Table

The Reserve Bank of India is heading into one of its most closely watched policy decisions in recent years, with most economists expecting interest rates to rise for the first time in nearly four years. 

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The six-member Monetary Policy Committee will announce its decision on Wednesday, October 7. Of the 40 economists surveyed by Bloomberg, 34 expect the repo rate to be raised by 25 basis points to 5.50%. The remaining six expect the RBI to leave rates unchanged. 

If the hike goes through, it would also be the first under Governor Sanjay Malhotra, who took charge in December 2024 and oversaw a series of rate cuts last year. 

The backdrop has changed considerably since the RBI’s previous meeting. Inflation has moved higher, crude oil has climbed back above $100 a barrel, the rupee has weakened and the US Federal Reserve has begun raising rates. 

Reasons for the Change in Expectations in Terms of Interest Rate Increase 

Inflation forms the core of the discussion. 

With inflation nearing 5% and expected to come closer to the higher end of the RBI’s range of tolerance between 2% and 6% during the quarter ending in December, there is increasing belief that a rate hike is justified. 

There is also worry owing to the rising price of oil. The conflict situation in the Middle East has caused crude prices to surpass the $100 mark per barrel, something that is undesirable for the Indian economy that depends largely on imports. 

Another factor is food prices due to weak monsoon rains in India. 

There was even worry about the persisting inflation among the members of the RBI itself during their previous session. 

Economists Expect a Shallow Rate-Hike Cycle 

A rate increase on Wednesday does not necessarily mean India is heading into an aggressive tightening cycle. 

Gaura Sen Gupta, chief economist at IDFC First Bank, expects the RBI to follow a relatively shallow path, with cumulative increases of 75 basis points by February. 

She said the increases would primarily be aimed at preventing the real policy rate from turning negative as inflation rises. 

Sen Gupta also cautioned that a shift away from the RBI’s neutral stance could point towards deeper tightening, which she believes would be difficult to justify while inflation remains largely driven by supply-side factors and risks to economic growth remain two-sided. 

The consensus expectation is that the RBI will retain its neutral stance on Wednesday, allowing policymakers flexibility over what comes next. 

Growth Gives RBI Some Room to Act 

A key advantage that the central bank enjoys is that the economy is resilient. 

Unlike being forced to deal with an increase in inflation even when growth is under stress, there is room for the policymakers to increase interest rates. 

Therefore, attention will not be only limited to the interest rate hike. 

Investors will be listening carefully to what Governor Malhotra has to say about whether Wednesday’s move is a one-off or the start of a long process of rate hikes. 

Samiran Chakraborty, the chief India economist at Citigroup, expects the central bank to hike its inflation forecast by 10 basis points to around 5%. 

The economist is also expecting the central bank to raise its growth forecast of 6.7% for the fiscal year ending in March 2027. 

Bond Market Already Reflects Rate-Hike Expectations 

The expectation of rate hike is already reflected in India’s bond market. 

The benchmark 10-year government bond yield stands at its highest level in two-and-a-half years at 7.23% after increasing by almost 30 basis points from September. 

According to VRC Reddy, chief treasury officer at Karur Vysya Bank, the bond yield will hover around current levels if the RBI comes up with a quarter-point hike and remains neutral. 

However, if RBI shows a more hawkish attitude, it will have a different impact on bond yields. According to Reddy, the bond yield will rise towards 7.38%-7.40% if RBI suggests a tighter policy regarding interest rates and liquidity. 

However, not all economists believe that rate hike is inevitable now. Alexandra Hermann Prasad of Oxford Economics referred to low core inflation as the reason why RBI can continue supporting growth. 

Excess Liquidity Creates Another Challenge 

Interest rates are just one of the many issues facing the policymakers. 

There is quite a lot of surplus cash in the banking system, keeping the overnight borrowing rates below the policy rate and making conditions easier than what the RBI might wish in the face of rising inflation. 

Most of this liquidity has been created due to the central bank’s decision to raise foreign-currency deposits after June. 

This policy attracted around $133 billion, which was much higher than the expected $50 billion-$85 billion. 

Although this helped India build its foreign exchange reserves, it has also caused significant liquidity in the Indian banking system. 

The RBI has withdrawn more than ₹1 trillion in the form of bond sales and other similar initiatives. 

Barclays economists believe the RBI will keep withdrawing liquidity through open market operations and currency swaps. An increase in the cash reserve ratio could also be considered but is unlikely. 

More Than the Repo Rate Will Matter on Wednesday 

That leaves Wednesday’s policy announcement with several moving parts. 

A 25-basis-point hike is the outcome most economists expect, but markets will also be watching the RBI’s stance, its revised inflation and growth forecasts, and what it plans to do with the surplus liquidity in the banking system. 

The rupee, crude oil and global interest rates have all changed the policy backdrop since August. 

So while the repo-rate decision will grab the headline, Governor Malhotra’s message on what comes after October could prove just as important.