Reserve Bank raises rates by 25 basis points; signals more tightening ahead

The Reserve Bank of India's Monetary Policy Committee raised the policy rate by 25 basis points, to 5.5%, on Wednesday. This marks the beginning of a new cycle of monetary tightening in the face of turbulent conditions in international commodity and capital markets. Despite these challenges, India's growth story is expected to remain strong and better than previously anticipated.

The hike will make loans, including mortgages, more expensive for businesses and individuals. Most experts believe that further rate hikes are likely in the coming months. The move was widely expected and reflects a shift from a neutral to a calibrated tightening stance. The RBI expects GDP growth for 2026-27 to be 7.1%, up from the previous August forecast of 7%, and 7% for 2027-28, barring any major shocks.

Inflation is projected to remain elevated, with the Consumer Price Index (CPI) at 5.2% for the fiscal year, up from the August forecast of 5%. Core inflation, excluding food and fuel, is expected to grow at 4.4%. Governor Sanjay Malhotra acknowledged the adverse inflation outlook due to supply-side constraints like monsoon deficiencies, El Niño conditions, and high energy prices.

External challenges such as geopolitical tensions in the West Asia region, rising bond yields, and the Federal Reserve's rate hikes have been cited as contributing factors to ongoing economic headwinds. The rupee closed at 96.78 against the US dollar, and the RBI maintains that markets are not yet fully recognizing the potential undervaluation of the rupee.

Overall, the MPC's decision indicates a cautious approach to rate hikes, with a 50 basis point hike cycle expected, though another hike remains possible if economic growth remains resilient.