RBI to Raise Repo Rate by 25 Bps Amid Generalisation of Price Pressures

The Reserve Bank of India's (RBI) era of falling interest rates is likely to come to an end this week. With bankers and economists predicting a 25-basis-point increase in the repo rate. This would mark the first hike since February 2023, which ended a tightening cycle that began after Russia's invasion of Ukraine.

Yes Bank's chief economist, Indranil Pan, suggests that the Reserve Bank of India is poised to kickstart its interest rate hike in October, driven by growing indications of price inflation. This decision is likely a response to the rising signs of inflation.

Which saw Q2 inflation surpass the RBI's 4.7% forecast, now nearing 6%, as input costs begin to erode consumer purchasing power.

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The impact of the repo rate hike is likely to be felt more rapidly in bank lending rates than in the bond market. The liquidity created by the FCNR(B) flows, which brought in $127 billion, could push some borrowers towards the bond market.

However, the relationship between bank borrowing and market funding is becoming increasingly seamless, with corporates able to move more easily between the two depending on relative pricing.

As inflationary pressures and global uncertainty intensify, the Reserve Bank of India is poised to navigate a delicate economic landscape. Aastha Gudwani, India's chief economist, believes the central bank will resist the urge to intervene, despite rising oil costs and a weakening currency.

Her forecast points to a potential interest rate hike on October 7. Driven by higher global oil prices and a resilient domestic economy, with the terminal rate expected to reach 5.75% by year-end.

Axis Capital chief economist Prateek Ancha expects a larger move. Citing the Fed's latest rate hike and dot plot as strengthening the case for 50bp of RBI tightening in CY26, split between October and December. He forecasts a 25-basis-point increase in October, with the overall hiking cycle expected to be limited to 75bp.

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IndusInd Bank chief economist Gaurav Kapur believes the probability of a 25-basis-point October hike is at 90%. The RBI's focus in the near term is likely to remain on draining surplus liquidity and bringing overnight rates back in line with the policy rate.

The RBI's decision is expected to have significant implications for the economy, with inflation and growth rates likely to be affected. As the central bank navigates this challenging environment, it will be vital to strike a balance between tightening monetary policy and supporting economic growth.

Experts warn that the RBI's actions will have far-reaching consequences. Impacting not only the bond market but also bank lending rates and the overall economy. As the situation continues to evolve, it will be essential to monitor the RBI's decisions closely and assess their impact on the economy.