When the RBI turns hawkish: Fighting inflation and a falling rupee

The first rate hike in 44 months signals a shift to calibrated tightening as food prices climb and the rupee slides.

After 44 months, the Reserve Bank of India has resumed the cycle of upward revision of repo rates. The measure is in line with the major central banks’ ameliorative actions, particularly those of the US Fed, to rein in emerging inflation. Alongside, the RBI has raised the daily cash requirement backing the banks’ cash reserve ratio. To shore up the value of the Indian rupee against other international currencies, particularly the US dollar, the RBI has mandated that commercial banks signing fresh foreign exchange contracts after November 1, 2026 maintain sizeable foreign exchange reserves with it. Curbing open-market liquidity, lowering effective demand in the economy and thereby the pace of emerging inflation seem to be the explicit objectives of the simultaneously initiated monetary measures.

After some 20 bi-monthly meetings of its Monetary Policy Committee (MPC), on October 7 the RBI outfit unanimously chose to marginally increase the repo rate (the rate at which the central bank lends overnight to commercial banks) from 5.25% to 5.5%. To tighten money availability in the market, it raised the minimum daily maintenance requirement under the cash reserve ratio (CRR) from 90% to 99%. CRR is the proportion of banks’ deposits that must be kept with the RBI, on which the central bank pays no interest.

Last week, to check the noticeable decline of the INR against the USD and other reserve currencies, the RBI, under its Foreign Exchange Risk Framework, lowered the cap on currency derivative contracts from $100 mn to $5 mn. It also prescribed that banks maintain with it a cash reserve equal to 20% of the rupee value of specified derivative transactions exceeding $2 mn. And to absorb what it deemed excess liquidity in the domestic market, on October 13 it sold Rs 25,000 crore of central government bonds through open market operations.

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Such steps are aligned with the RBI’s announcement, made alongside the repo rate increase, that it would pursue a policy of “calibrated tightening” in the near future. This approach marks a shift from its earlier stance of remaining “neutral” in its policies and operations. It also indicates that in its forthcoming MPC meetings, repo rate increases and other measures of the kind recently undertaken would remain on the table.

Several market analysts portend a further rise in rates of 50 basis points, undertaken in two lots of 25 points each, which would take the repo rate to 6%. Commercial banks have so far not raised their lending rates to the full extent of the rise in their borrowing costs, wary of dampening consumer demand during the ongoing festive season. Going forward, however, transmission to lending rates can be expected to catch up with the higher repo rate.

THE SPECTRE OF INFLATION IN INDIA

For the last four months, the consumer price index (CPI) has remained above 4%, the RBI’s mean threshold. In September 2026, it was 5.5%, fairly close to the RBI’s upper ceiling of 6%. Amongst the major factors which have caused it are steadily increasing food prices, particularly of pulses, onions, tomatoes and lemons. A 12.6% rainfall deficit in the now-receding monsoon has shrunk the area sown under the Kharif (summer) crop, and the resulting output shortfall could be around 5%, particularly in paddy and millets.