RBI turns hawkish, but economists expect shallow rate hike cycle
The RBI has raised the repo rate by 25 bps to 5.50%. Economists weigh in on whether this hawkish turn signals a deep or shallow tightening cycle.
In a decisive move to combat rising inflationary pressures, the Reserve Bank of India (RBI) has raised the repo rate by 25 basis points to 5.50 per cent. The central bank has also shifted its monetary policy stance to "calibrated tightening," signaling a more aggressive approach to managing the economy. While the move has sent a hawkish signal to the markets, many economists believe that this tightening cycle may not be as deep as some fear.
Inflationary pressures and growth forecasts
The RBI's decision comes at a critical juncture, as the ongoing conflict in West Asia has heightened global inflationary risks. Despite these concerns, the central bank remains optimistic about India's economic trajectory, raising its FY27 real GDP growth forecast to 7.1 per cent. This upward revision points toward sustained strength in economic activity and robust credit demand across the country.
Banking leaders and economists suggest that the primary objective of this policy shift is to anchor inflation expectations while ensuring macroeconomic stability. However, there is a lack of consensus on how many more hikes might follow.
A "shallow" cycle? Historical precedents
Not all experts believe a massive wave of rate hikes is on the horizon. Rajani Sinha, Chief Economist at CareEdge Ratings, suggests that the current tightening cycle could remain relatively shallow. She pointed to a historical precedent from October 2018, when the Monetary Policy Committee (MPC) also adopted a "calibrated tightening" stance, only to pivot to a "neutral" stance and begin a rate-cutting cycle by February 2019.
Sinha noted that:
- The current cycle might only see another 25-50 bps of rate hikes.
- Policy tightening could provide much-needed support for the rupee.
- Effective liquidity management will be crucial, as rate hikes may lose impact without corresponding liquidity tightening.
Impact on borrowers and the banking sector
The shift in stance has immediate implications for the financial landscape. Ajay Kumar Srivastava, Managing Director and CEO of Indian Overseas Bank, noted that the move effectively puts rate cuts "off the table" for the near term. This will likely impact various segments of the economy:
- Home Loan Customers: Borrowers can expect higher interest costs.
- Small Businesses: Increased cost of credit may impact operational margins.
- Banks: Financial institutions will need to balance passing on higher rates to customers while supporting productive credit demand.
Radhika Rao, Senior Economist and Executive Director at DBS Bank, emphasized that the RBI's hawkish intent is reinforced by the upward revisions to both growth and inflation forecasts. She noted that liquidity normalization is essential to ensure that policy transmission remains effective.
Resilient credit demand despite higher rates
Despite the tightening, the outlook for credit remains positive. Dipti Deshpande, Senior Director and Principal Economist at Crisil, anticipates another 25 basis point hike could arrive as early as December. However, she remains bullish on the banking sector's performance.
"Even with higher interest rates, we expect bank credit growth to rise 14.5-15.5 per cent this fiscal year, reflecting resilient credit demand and improving economic activity," Deshpande stated.
Brajesh Kumar Singh, MD and CEO of Canara Bank, echoed the sentiment that the 25 bps hike is a necessary response to the geopolitical tensions in West Asia, aimed at maintaining stability in the face of global uncertainty.