EXPECT A 25-BPS RATE HIKE IN OCTOBER

EXPECT A 25-BPS RATE HIKE IN OCTOBER

As the RBI Monetary Policy Committee (MPC) commences its 3-day meeting on 05-October, the markets are almost in sync that there will be a 25-bps rate hike. We have to await the monetary policy statement on 07-October, but the RBI may have very limited options. With inflation at 4.82%, and expected to move up to 6% by December 2026, price stability is a major factor. Secondly, oil has been above $100/bbl in the Brent market and today the issue is not just about supply constraints but also about substantially depleted SPRs.

Then there is the monetary policy divergence that India would be cautious about. The Federal Reserve has already hiked Fed rates by 25 bps in September. The CME Fedwatch is hinting at one more rate hike in 2026 and two more in 2027. However, the biggest factor for the RBI may be the persistent weakness of the rupee, despite the $133 billion of FCNR(B) inflows. A rate hike of 25-bps with a hawkish outlook will not only address inflation, but also bridge the monetary divergence gap and offer support to the rupee value.

RECAP OF KEY ANNOUNCEMENTS OF AUG-26 MONETARY POLICY

Here are key highlights of the August 2026 policy statement.

RBI MPC held the repo rate at 5.25% in the August meeting; and kept the stance of the monetary policy at Neutral. This also kept SDF rate and MSF/Bank rate at same levels.

The FY27 GDP growth estimate was upped by 10 bps from 6.6% to 6.7% in August; to reflect strong domestic demand factor amid global supply chain constraints.

The inflation forecast for FY27 was cut by 10 bps to 5.0%, to account for limited impact of weak monsoons on Kharif and a fall in gold and silver prices.

Let us turn to the specific expectations from October 2026 monetary policy.

WILL RBI HIKE RATES IN OCT-26 POLICY?

The rate hike case has gotten really strong in recent weeks. Both CPI and WPI inflation have been on a persistent uptrend. Most of the major central banks including the Federal Reserve, ECB, Bank of Japan, Reserve Bank of Australia, as well as the central banks of Korea and Philippines have hiked rates to control inflation. If India does not hike rates, it may face monetary divergence. El Nino is a major risk and this year the rainfall deficit could be as high as 13%. While Kharif may be at par, Rabi output is expected to be sharply lower.

In the last 2 weeks, the RBI has expended close to $40 billion trying to defend the rupee. The impact was limited as the USDINR closed well beyond ₹96.40/$. With the RBI forward dollar position touching $200 billion, the pressure on the rupee is likely to continue. The only viable option is to hike rates and also provide a hawkish communication. This would plug the pace of FPI outflows and automatically help the rupee to recover. A rate hike of 25-bps in October with guidance of 25-bps in December looks to be on the cards.

WILL RBI CHANGE ITS STANCE FROM “NEUTRAL” IN AUG-26?

Broadly, the question of shifting from “Neutral” to “Accommodative” is now ruled out. The big question is whether the government would really stick its neck out and change the stance to “Tightening.” A more rational option is for the RBI to call its stance “Calibrated Tightening.” That will give an appropriate picture of direction, without appearing too antagonistic to the broader economic growth objective.

It is more likely that the RBI may retain its “Neutral” stance and instead put most of the hawkishness in the communication. That would give the appropriate message to the market that the RBI is dead serious about containing inflation, without disrupting the growth engine. That looks more likely at this juncture, especially considering that the global geopolitical situation is still in a state of flux.

WILL RBI RAISE FY27 REAL GDP GROWTH ESTIMATES?

In the August monetary policy, the RBI had hiked the GDP estimates for FY27 by 10 bps to 6.7%. However, this came on the back of an 80-bps downgrade in the April and June policy statements. With the Q1GDP estimates coming in at a robust 7.8%, the 6.7% for FY27 is clearly out of sync. However, real GDP growth is also a function of inflation and the GDP deflator is likely to put pressure in the coming quarters. The RBI could, most likely, hike the GDP growth estimates for FY27 by 30-40 bps to the range of 7.0%-7.1% to better reflect current economic reality and the robust domestic consumer demand.

WILL RBI CHANGE FY27 INFLATION ESTIMATES?

In the August 2026 monetary policy, the RBI had cut the inflation expectation for FY27 by 10 basis points to 5.0%. However, CPI and WPI inflation continue to be on the higher side. However, the RBI has already hiked the inflation estimates in a front-ended manner in the April and June policies. Hence, the RBI will restrict itself to minor tweaks to the inflation estimate of around 20 bps to 30 bps, taking it to the level of 5.2% to 5.3%. This will be in sync with the inflation estimates touching 6.0% by the end of December quarter. Of course, if the situation in the Middle East normalizes and oil prices start to come down, the RBI always has the option of lowering its inflation estimates in subsequent policies.

HOW WILL RBI MANAGE THE LIQUIDITY IN THE SYSTEM?

On the liquidity front, the total rupee liquidity created by the FCNR(B) flows was around ₹12 trillion. However, RBI has already absorbed more than 50% of the amount through its market operations. The recent dollar selling by the RBI to defend the rupee will also be a key factor in reducing the rupee liquidity. Credit deployment of the funds has also started, so the real hard work on the liquidity management front may already have been done.

The 3-day MPC meet will culminate on 07-October with the policy announcement. The RBI has two options. Firstly, it may hike rates by 25-bps and guide for another 25-bps in December. The second option is that the RBI may front-load the full 50-bps in October itself. For now, the former choice looks more likely!