RBI hikes interest rate for first time in nearly four years, signals more tightening

MUMBAI: The Reserve Bank of India raised its benchmark repo rate by 25 basis points to 5.50 per cent on Wednesday, its first hike in nearly four years, while signalling that rate cuts are off the table in the near term and that further hikes could follow amid rising inflation, a weak rupee and high crude oil prices.

The six-member Monetary Policy Committee (MPC) of the RBI voted unanimously to raise the repo rate, and sprang a surprise with a shift in policy stance to "calibrated tightening" from "neutral".

The decision to change the policy stance was taken with a 4:2 majority.

External members Nagesh Kumar and Ram Singh were of the view that the policy stance should be retained at neutral, the RBI said in its policy statement.The hike in the repo rate -- the first in the tenure of Governor Sanjay Malhotra, who assumed office in December 2024 -- comes as key global central banks raise rates due to pressure from high oil prices following the West Asia crisis, weak currencies, and the impact of El Nino.

"Rate cuts are off the table in the near term and policy action ahead can only be a rate hike or a pause, depending on the evolving conditions and the outlook," Malhotra said while announcing the MPC's decisions.

He, however, cautioned that the timing and extent of any further tightening would depend on the evolution of inflation and growth, particularly underlying price pressures and the extent to which supply shocks become embedded in the broader economy.

India's consumer-price inflation rose to 4.82 per cent in August - above the RBI's 4 per cent medium-term target for a third consecutive month, while core inflation accelerated to 4.2 per cent.

The RBI said inflation risks were no longer as benign as they had been a year earlier, pointing to higher food and fuel prices, deficient monsoon rains, El Nino conditions and renewed volatility in international oil prices.

"There are also early signs of inflation becoming generalised," Malhotra said.

The RBI marginally raised the forecast for retail inflation for the current fiscal to 5.2 per cent from its earlier estimate of 5 per cent, and said price pressures are increasingly becoming visible across a range of commodities.

Oil prices have emerged as a particular risk following the renewed escalation of the West Asia conflict. The Indian crude basket averaged USD 116.1 a barrel in September, up sharply from USD 82 in July, the RBI said.

The RBI also raised the GDP growth forecast for 2026-27 by 40 basis points to 7.1 per cent, after the economy expanded 7.8 per cent in the first quarter.

Economic activity remained resilient in the second quarter, although momentum had moderated. Manufacturing and services continued to expand, while indicators such as capital-goods production, credit growth and consumer spending remained supportive, the RBI said.

"The Indian economy has been strong, and the economic momentum remains broad-based," Malhotra said.

The policy shift marks a balancing act between containing an increasingly broad inflation shock and preserving strong domestic growth. It said the duration and extent of the rate-hike cycle would depend on actual growth and inflation outcomes, particularly the persistence of underlying inflation and second-round effects from supply shocks.

"We shall strive for price and financial stability as both are essential for sustainable growth in the long run," Malhotra said.

With Wednesday's rate increase, economists see the beginning of a new rate hike cycle.

"We continue to see 25-50 basis points of additional rate hikes going ahead, with further upside if global risks persist," said Upasna Bhardwaj, Chief Economist, Kotak Mahindra Bank.

According to HDFC Bank Principal Economist Sakshi Gupta, "We expect cumulative rate hikes by the central bank to the tune of another 50-75 bps over the next few months. The risk of a more aggressive rate hike cycle hinges on whether the current West Asia conflict and rise in oil prices continue to linger on for longer."

The inflation prints are expected to harden moving forward, on account of a combination of factors such as the poor monsoon, rising commodity prices and an unfavourable base effect, setting the stage for another rate hike in December, as of now, ICRA Chief Economist Aditi Nayar said.

CREDIT GROWTH

The hike in interest rates may lead to moderation in banks' credit growth from the present levels of over 18 per cent, but is unlikely to impact broader economic expansion, the RBI said.

Speaking to reporters after the policy announcement, Deputy Governor Swaminathan J said it typically takes around two quarters for the hikes to get transmitted to actual lending rates for end borrowings.

"Some moderation will occur relating to demand as well as rate (hike) together. But the moderation from 18 to 20 per cent (credit growth) is not bad and will be adequate enough to support growth," the commercial banker-turned central banker said.

He added that the credit growth is coming at a decadal high of over 18 per cent at present, as against the ten-year average of 12-14 per cent and hinted that the loan books expansion at the average rate is sustainable for the system.

To another query earlier at the press conference, Governor Malhotra said that a few percentage points "here and there" should not matter too much.

"Will it (credit growth) moderate going forward? I think it (credit growth) will continue to be strong. A few percentage points here and there should not really matter too much in the overall scheme of things," he said, adding that the credit growth will continue to support economic growth.

He said the RBI is conscious of adverse impact on asset quality at non-bank lenders amid a flush of liquidity, but made it clear that the central bank does not expect any such eventuality to play out.

The system liquidity will not be in such a high surplus as seen in the last few weeks for a very long time, he added.

On MDR, Malhotra said levying a "small fee" in the form of merchant discount rate (MDR) will not have a "major impact" on UPI transaction volumes.

"As of now, we do not see any drop in volumes. And I don't personally think that a small fee will have a major impact on the volumes," he told reporters at the central bank headquarters here.

Last month, the government allowed charging MDR under which transactions above Rs 2,000 will attract a fee of 0.4 per cent.

RUPEE AND STOCKS

Stating that the rupee may be "undervalued" as per many estimates, Malhotra assured that the RBI will ensure that the currency "stabilises" and will support it in reaching its "correct value".

He said that while markets can be "irrational" in the short term, they reflect their right value in the long run.

"We will ensure that the rupee stabilises, that the rupee finds its correct value, and we will support an orderly movement of the rupee in finding its correct value and at the same time in ensuring that there is no excessive volatility," he told reporters, replying to a specific question about the rupee inching towards its all-time low of 96.96 against the dollar in intraday trade on Wednesday.

The rupee slumped 43 paise to close at 96.78 (provisional) against the US dollar. Stock markets closed lower, with the benchmark Sensex down 429 points after two straight days of gains.

The 30-share BSE Sensex fell 429.11 points, or 0.59 per cent, to settle at 72,638.70. During the day, Sensex lost 599.09 points, or 0.81 per cent, to hit a low of 72,468.72.

The 50-share NSE Nifty declined 173.05 points, or 0.76 per cent, to end at 22,603.05.