RBI Raises Repo Rate to 5.50% as Inflation Risks Increase

MPC shifts stance to calibrated tightening and raises FY27 GDP growth forecast to 7.1%

The Reserve Bank of India’s Monetary Policy Committee (MPC) has unanimously raised the policy repo rate by 25 basis points (bps) from 5.25% to 5.50%, while changing its policy stance from ‘neutral’ to ‘calibrated tightening’. The decision comes amid higher inflation risks, global economic uncertainty, elevated commodity prices and concerns over supply conditions.

The RBI has also raised its FY27 GDP growth projection by 40 bps to 7.1%, while increasing its FY27 inflation forecast by 20 bps to 5.2%.

FY27 Growth Forecast Raised to 7.1%

The Indian economy has continued to show resilience despite global economic headwinds. GDP grew 7.8% year-on-year in Q1 FY27, while indicators including IIP and ISP growth and bank credit offtake have pointed to continued momentum into Q2 FY27.

Merchandise and services exports grew 22.8% and 13.5% YoY, respectively, during July-August FY27. Investment indicators also remained positive, with capital goods production increasing 17.9% YoY during July-August FY27 and central government capex rising 8.5% over the same period.

Consumption has remained broadly steady, although some weakness has emerged in areas such as non-durable consumption and domestic air passenger traffic.

The RBI has significantly raised its growth projections for Q2 and Q3 FY27 by 80 bps and 40 bps, respectively.

RBI Growth Outlook (%)

The RBI continues to monitor downside risks, particularly the effects of geopolitical tensions and potential El Niño conditions on kharif output and rabi sowing. Any significant impact on agricultural production could affect rural consumption demand.

Inflation Projection Raised to 5.2%

The RBI has raised its FY27 inflation projection by 20 bps to 5.2%, with inflation expected to average 5.9% in H2 FY27, compared with the earlier estimate of 5.7%.

Food inflation remains a key risk. The monsoon has been 13% below normal, while Maharashtra has declared a drought in around 265 of the state's 358 talukas, covering nearly 74% of the state.

The Union Agriculture Minister has also raised concerns about possible drought conditions in Karnataka, Telangana, Andhra Pradesh and Rajasthan.

Reservoir levels across India are around 20% below last year's levels, creating risks for rabi sowing and crop output.

Global food prices are adding to the pressure. Strengthening El Niño conditions in Asia have contributed to higher global food prices, with edible oils rising 16.4% YoY and cereals increasing 10% YoY.

The report expects food inflation to peak at 7.7% in Q3 FY27 and average around 6.2% for FY27.

Industrial metals and energy prices have also remained elevated. WPI inflation and output PPI inflation stood at 9.9% and 9.8%, respectively, in August 2026.

The RBI has also increased its FY27 core inflation projection by 10 bps to 4.4%, citing signs of broader inflationary pressures and elevated inflation expectations.

RBI Inflation Outlook (%)

External Sector Shows Resilience

India's external sector has remained relatively stable despite global uncertainty and elevated energy prices.

Merchandise exports increased 17.6% YoY during April-August FY27, while services exports rose 10.8% over the same period. Remittances increased 28.6% YoY.

The outlook estimates India's current account deficit at 0.8-1.2% of GDP in FY27.

Inflows from the FCNR, ECB and OFCB schemes amounted to USD 143 billion. Gross FDI increased 12.6% YoY during April-July FY27 to USD 43.9 billion, while net FDI grew 38.1% during the period.

FPI recorded a net outflow of USD 11.8 billion between April and October 6, 2026.

The capital account is expected to record a surplus of USD 155 billion in FY27, compared with USD 6 billion in FY26. The balance of payments is projected to move to a surplus of USD 114 billion, compared with deficits of USD 23 billion in FY26 and USD 6 billion in FY25.

Despite strong FCNR inflows and the expected balance of payments surplus, the rupee could remain volatile due to global crude prices, FII flows, US yields and the US Federal Reserve's rate-hiking cycle. The outlook expects USD/INR to trade in the 94-96 range by the end of FY27.

RBI to Manage Excess Liquidity

Banking system liquidity has also undergone significant changes. The daily average surplus increased from Rs 3.7 trillion in August 2026 to Rs 10.4 trillion in the first half of September.

Following open market operations (OMO), variable rate reverse repo (VRRR) operations and FX swaps, along with quarter-end advance tax outflows, system liquidity declined to Rs 4.9 trillion in the first week of October.

However, the surplus remains above the average of Rs 1.9 trillion recorded during H1 CY 2026.

The RBI is expected to continue using a combination of VRRR operations and OMOs to manage liquidity. The Governor has indicated that a CRR hike is the least preferred option for managing liquidity, although it has not been ruled out.

Additional liquidity absorption could come from higher festive-season currency demand, the maturity of RBI short-dollar forward positions and higher CRR accretion linked to deposit growth.

Government Bond Yields Expected to Remain Elevated

Geopolitical uncertainty in West Asia and elevated global energy prices, combined with rate-hike cycles in major advanced economies, have contributed to higher Indian bond yields.

The 10-year G-Sec yield crossed 7% in September, while FPI outflows from the debt segment also contributed to the rise.

The outlook expects the 10-year G-Sec yield to remain elevated at around 7.3-7.4% by the end of FY27, considering expected RBI rate hikes and OMO activity.

RBI Opens Scope for Further Rate Hikes

The RBI's move to ‘calibrated tightening’ indicates that rate cuts are no longer expected in the current policy cycle.

The stance was last adopted by the MPC in October 2018 and was changed to ‘neutral’ in February 2019, alongside a 25-bps rate cut that marked the beginning of a policy-easing cycle. Despite adopting the calibrated tightening stance in October 2018, the RBI did not subsequently raise rates further.

Against this historical precedent and expectations of headline inflation moderating from Q4 FY27, the outlook expects the current rate-hiking cycle to remain relatively shallow, with scope for another 25-50 bps of rate hikes.

Policy tightening could also provide support to the rupee, particularly as major global central banks continue to raise rates.