India's Central Bank Raises Repo Rate for the First Time in Nearly Four Years
The Monetary Policy Committee of the Reserve Bank of India raised the repo rate by 25 basis points to 5.50% after its meeting from October 5 to 7, marking the first rate hike since February 2023. All six members voted unanimously in favor of the increase.
The policy stance shifted from neutral to calibrated tightening, with the vote tally being 4 to 2. Governor Sanjay Malhotra stated that recent rate cuts are no longer an option, and the next steps could only be a rate hike or a pause. The standing deposit facility rate was adjusted to 5.25%, while the marginal standing facility rate and bank rate were set to 5.75%.
The last rate hike occurred in February 2023, when it was raised by 25 basis points to 6.50%. Malhotra, who took office as governor in December 2024, implemented this increase as his first adjustment to the policy rate. A majority of economists surveyed by Bloomberg had anticipated this rate hike.
Factors triggering this decision include oil prices, monsoon conditions, and exchange rates. The consumer price index rose to 4.8% in August, the highest in 22 months, exceeding the 4% target. The governor indicated that the average overall inflation for the next three quarters is expected to be close to 5.8%, with a core inflation forecast of 4.4% for the current fiscal year. The conflict in West Asia has pushed oil prices above $100 per barrel, while weak monsoon conditions and a depreciating rupee have contributed to imported inflation.
Growth forecasts remain unchanged. The GDP growth rate for the fiscal year 2026-2027 has been revised up from 6.7% to 7.1%, and the inflation forecast for that fiscal year has been adjusted from 5.0% to 5.2%. The governor stated that the duration of the rate hike cycle depends on underlying inflation, second-round effects of supply shocks, and demand. Government bond yields rose following the announcement.
Buyers include foreign investors chasing the rupee asset spread and domestic funds allocating to short-term debt, while sellers are long-term government bonds and companies reliant on floating-rate loans. The event is driven by oil prices and exchange rates, with funds shifting from growth trades to inflation protection trades. Beneficiaries include banks' net interest margins and short-term deposits, while housing loan borrowers, highly leveraged companies, and long-term bondholders face pressure.
Source: Public Information
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The last round of rate hikes in India ended in February 2023 at 6.50%. After that, the committee paused and cut rates, bringing the repo rate down to 5.25%. After Malhotra took office in December 2024, he maintained an accommodative stance. This return to rate hikes acknowledges that the rate-cutting cycle post-2023 was interrupted by oil prices and exchange rates, rather than by overheating domestic demand.
The capital path first follows exchange rates and bonds. When the rupee weakens, raising rates provides a spread for foreign capital, preventing the Reserve Bank from continuously selling dollars to stabilize the exchange rate. After government bond yields rise, the rolling costs for the government and mortgage borrowers change first, while banks directly pass the repo rate into loan benchmarks. The path in 2022 was similar: oil price shocks first impacted the current account, then affected interest rates.
A comparison can be made to the synchronized tightening of the Federal Reserve and the Reserve Bank of India in 2022, as well as the follow-up rate hikes in Indonesia and the Philippines under pressure from oil prices and exchange rates. The difference this time is that growth forecasts are still being revised upwards, indicating that we are at the first step of a cycle switch, rather than already in the midst of consecutive rate hikes.
This represents a shift in pricing power. Oil prices and monsoon conditions determine food and energy prices, while the Reserve Bank can only use interest rates to price second-round inflation. By removing the option for rate cuts, the bond market no longer prices based on growth trades, but rather on the probability of the next 25 basis point hike.
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Raising rates to protect the exchange rate can simultaneously revise growth forecasts upwards.
The first step of a rate hike changes the path, not the endpoint.
Oil prices determine imported inflation, while interest rates determine second-round costs.