RBI likely to hold repo rate in Oct policy, begin 50-75 bps hike cycle in Dec: BoB

The Reserve Bank of India is anticipated to maintain the repo rate unchanged during its October policy meeting, even as inflation concerns intensify, before initiating a tightening cycle in December that could result in a cumulative 50-75 basis point increase, as per a report by Bank of Baroda (BoB). BoB stated that credit and deposit growth in India remains robust, with the gap between the two narrowing significantly due to a rise in foreign currency non-resident (FCNR(B)) deposits.

The country's credit growth has also been evenly distributed, primarily driven by the industrial and services sectors, with infrastructure and export-oriented industries outperforming within the industrial lending segment.

During the Monetary Policy Committee (MPC) meeting, the BoB anticipates the RBI to keep the repo rate, as well as the policy stance, unchanged at 5.25%, adopting a cautious tone. This decision comes amid a sharp surge in crude prices by 28 percent due to renewed tensions between the United States and Iran, a 25 basis point increase in US Federal Reserve rates, a 44 basis point rise in Indian bond yields, and an escalation in India's headline consumer price index (CPI) inflation to 4.8 percent.

BoB's outlook is based on robust GDP growth, rising inflation, increased festive demand, and higher bond yields. The bank noted that India's GDP growth surpassed expectations in the first quarter of FY27, expanding 7.8 percent against the RBI's forecast of 7 percent, fueled by stronger investment and consumption. According to BoB, India's GDP growth momentum remained strong in the second quarter despite global volatility, with manufacturing and services PMIs rising to 55.1 and 55.8, respectively, from 52.8 and 54.1 in the previous month.

The bank expects GDP growth to stay within the range of 7-7.2 percent in FY27, giving the RBI the flexibility to keep rates steady at the moment.

While inflation has risen to 4.8 percent, it remains within the RBI's 2-6 percent target range, with food prices driving the pressure and core inflation remaining contained. BoB believes that an immediate rate hike, particularly before the festive season that marks peak spending, could slow down demand momentum and impact growth prospects. Additionally, the surplus liquidity in the system may complicate the transmission of a rate hike.

Lastly, BoB highlighted that India's 10-year bond yield has increased 44 basis points to a 29-month high of 7.12 percent since the last RBI policy, driven by higher oil prices, foreign portfolio investors (FPI) outflows, and expectations of rate hikes. Keeping rates unchanged could help alleviate the upward pressure on yields. The bank expects the RBI to only hike rates in December 26, with a cumulative 50-75 basis point increase anticipated in this cycle.