As the Reserve Bank of India’s (RBI) Monetary Policy Committee concludes its meeting on Wednesday, expectations of a rate hike, heralding the start of tighter monetary policy, have risen sharply. Mint explains what has driven the shift and what it could mean for the economy.
What are the chances of a rate hike?
Quite high. Nine out of 10 economists polled by Mint last week are certain that the RBI will increase the repo rate, its benchmark interest rate, on Wednesday.
This is because the macro environment has changed dramatically in recent weeks. Inflation is above the RBI’s comfort zone and inflationary pressures are rising due to higher Oil and other commodity prices. shocks remain.
That apart, advanced economies have started tightening their monetary policies. This has added pressure on the central bank to increase key policy rates to protect capital flows. A 25-basis-point (bps) increase in is widely expected.
How bad is the inflationary pressure?
In August, the consumer price-based inflation rose to 4.8%, higher than RBI’s mid-point target of 4%. More worrying, inflationary pressures are rising.
Oil prices have shot past the $100-per-barrel mark, and are expected to remain high as the shows no signs of abating. With supply chain shocks refusing to go away and causing a deficit in southwest monsoon rainfall, price increases have become more broad-based beyond just a few items.
RBI had earlier estimated fiscal year 2027 (FY27) inflation at 5%, with some experts now projecting a rise to 5.2%.
Are external factors playing a part too?
Yes. In the last few weeks, central banks of many advanced economies have started tightening their monetary policies. On 16 September, the increased its benchmark interest rate range by 25 bps to 3.75% to 4% and more hikes are expected going forward.
This makes debt investments in the US more attractive. RBI needs to necessarily increase rates to keep Indian debt competitive and stem possible capital outflows.
How will this impact economic growth?
In the first quarter of FY27, India’s economy grew surprisingly fast at 7.8%, outpacing RBI’s estimate of 7% expansion, despite domestic and global headwinds. This growth was broad-based and supported by expansion in manufacturing, services, exports, private investment, and private consumption.
It is this robust growth that could well give the RBI the room to go ahead with a rate hike. If this growth momentum sustains, a small hike in interest rates is unlikely to slow the economy. Some experts expect the central bank to revise its FY27 growth forecast upward from its earlier estimate of 6.7%.
How deep will the monetary tightening be?
Experts differ on the extent of monetary tightening. Goldman Sachs expects a 25-bps hike in October, followed by a similar increase in December. It also expects another 50-bps hike in the first six months of 2027. Others expect an overall 50-75 bps hike in interest rates between now and February 2027.
Experts say that the depth of the current tightening cycle will depend on how inflation plays out. How well the Indian economy tackles the headwinds and grows will also be a crucial factor that the RBI will consider when deciding on rate hikes going forward.