With the retail inflation rate in the third quarter expected to peak at 6.1 per cent, breaching the upper limit of the Reserve Bank of India’s tolerance band, the Monetary Policy Committee may increase the repo rate by 50 basis points (bps), with economists expecting the upward climb to be staggered equally between the policy meetings in October and December.
Economists expect the rate to ease in the fourth quarter.
Prices of crude oil have crossed $100 a barrel amid renewed tensions in West Asia. Continuing El Niño concerns, the likely narrowing of the differential between the rates in India and the United States (US) as the Federal Reserve moves towards rate increases, and strong growth in gross domestic product (GDP) are key factors that could influence the RBI’s decision.
The retail inflation rate rose to 4.82 per cent in August from 4.45 per cent in July, driven by a broadbased increase across almost all divisions. The rate for rural areas rose to 5.23 per cent, while its urban equivalent stood at 4.31 per cent.
The food inflation rate rose to 5.66 per cent due to elevated prices of select items.
The core inflation rate, which excludes food and fuel, household goods and services, and transport, rose to 4.16 per cent in August from 3.87 per cent in July.
According to economists at HSBC, led by Pranjul Bhandari, which is chief India economist at the bank, the September rate is tracking at 5.5 per cent with vegetable prices going up sharply in the first 10 days of the month.
Broader pressures on food prices are also building up, with sugar and edible-oil prices firming up ahead of the festival season.
At this pace, the average inflation rate in Q3FY27 is trending around 4.9 per cent, above the RBI’s 4.7 per cent projection.
“Our forecasts suggest that inflation will remain above 5 per cent for about nine months. We expect the RBI to hike policy rates by 25 bps each in the October and December policy meetings, taking the repo rate to 5.75 per cent,” HSBC economists said in a report on Tuesday.
Sonal Verma and Aurodeep Nandi, economists at Nomura, said.
“In light of the faster surge in food and oil prices, and our forecast suggesting headline inflation will likely reach and/or breach the 6 per cent ceiling in October-November, we are changing our call from a hold to a 25 bps hike each in October and December, taking the repo rate to 5.75 per cent … The October MPC meeting is live, but it is not a done deal. We assign a 60 per cent probability to a 25 bps rate hike in October versus 40 per cent to a rate hold, premised on still-benign super core inflation.”
According to SBI Research, the retail inflation rate may cross 6.5 per cent before falling below 6 per cent in early 2027.
“Time to build moats through a 25 bps hike in October and December monetary policy committee (MPC) meetings each, and then to pause and take stock with upcoming data,” said SBI Research in a report authored by Soumya Kanti Ghosh, group chief economic adviser, State Bank of India (SBI).
Ghosh also said the rate-increase cycle was expected to be shallow, with cumulative hikes of 50-75 bps, because it is driven by the normalisation of inflation rather than a generalisation of price pressures.
Gaura Sen Gupta, chief economist at IDFC First Bank, said in a report: “The rate hike cycle could start in October or December, with a higher probability of an October start given that inflation is expected to peak in Q3FY27.”
She added that the September rate was tracking at 5.6 per cent year-on-year, led by prices of food and fuel and adverse base effects.
Meanwhile, MUFG expects the RBI to up rates by 50 bps, with 25 bps each in the December 2026 and February 2027 meetings.
“We see some risk that the RBI could deliver 75 bps of hikes in this cycle. Overall, this would bring the RBI’s repo rate to 5.75 per cent by end-FY2026/27,” MUFG said in its report, adding that their base case was for a shallow rate-increase cycle, given the much better starting point for India’s macro stability.
“Nonetheless, there are some left-tail risks that RBI may eventually be forced to hike rates at a faster pace down the road, especially if credit growth and abundant liquidity conditions are not managed well,” the report flagged.
The money that has come through Foreign Currency Non-Resident (Bank) deposits has given the RBI bigger firepower to curb rupee weakness, but it has also brought about its own set of challenges, namely rupee liquidity management.
“The RBI’s most immediate challenge is to deploy its suite of tools to mop up this excess liquidity as a side effect of the inflows from these FX measures, which now stands at more than INR 10 trillion. Importantly this is coming at a time when credit growth in India is accelerating, domestic demand and growth is resilient, fiscal policy is supportive, and inflation looks to be picking up into 2027 in part due to possible adverse weather events and elevated global oil prices,” said MUFG in its report.
According to SBI Research, the mobilised amount of $127 billion almost matches the fund gap in the banking system.
“This implies that the current spike will have a natural drawdown given the strong demand for credit supported by equally strong Q1 FY27 GDP growth figures. Thus, in all likelihood, the system liquidity will level out by the end of FY27 if the anticipated credit demand is met”, Ghosh wrote in the report.
