As retail inflation is expected to peak at 6.1 percent in the third quarter, surpassing the upper limit of the Reserve Bank of India's (RBI) acceptable range, the Monetary Policy Committee may increase the repo rate by 50 basis points (bps). Economists predict that this increase will be distributed evenly across the meetings in October and December.
Experts believe that the rate will begin to decline in the fourth quarter. Factors influencing the RBI's decision may include rising crude oil prices above $100 per barrel amid renewed tensions in West Asia, concerns over ongoing El Niño, the likely narrowing of the interest rate differential between India and the US as the Federal Reserve moves towards rate hikes, and strong Gross Domestic Product (GDP) growth.
Retail inflation rose to 4.82 percent in August from 4.45 percent in July, driven by broad increases across almost all categories. In rural areas, this figure stood at 5.23 percent, while in urban areas, it reached 4.31 percent. Food inflation increased to 5.66 percent due to higher prices for specific commodities.
Core inflation, excluding food and fuel, household goods, and transport, rose to 4.16 percent in August from 3.87 percent in July. According to HSBC economists led by Pranjul Bhandari, the September figure is estimated at 5.5 percent due to a sharp rise in vegetable prices during the first ten days of the month.
Pressure on food prices is intensifying as prices for sugar and vegetable oil rise ahead of the festive season. At current rates, average inflation in the third fiscal quarter of 2027 is approaching 4.9 percent, which is higher than the RBI's forecast of 4.7 percent.
Forecasts and Recommendations of Analytical Agencies
HSBC economists reported in a Tuesday report that their forecasts suggest inflation will remain above 5 percent for about nine months. They expect the RBI to raise interest rates by 25 bps at the October and December meetings, bringing the repo rate to 5.75 percent.
Sonal Verma and Aurodeep Nandi, economists at Nomura, noted that in light of faster food and oil price increases, and the forecast that headline inflation is likely to reach or exceed the 6 percent ceiling in October-November, they are changing their recommendation from holding the rate to raising it by 25 bps in October and December, setting the repo rate at 5.75 percent. They pointed out that the MPC meeting in October is underway, but this is not yet a final decision, assigning a 60 percent probability of a 25 bps hike in October versus a 40 percent probability of maintaining the rate, based on relatively stable core inflation.
According to SBI Research, retail inflation could exceed 6.5 percent before falling below 6 percent in early 2027. In their report, SBI Research author Sumya Kanti Ghosh advised to 'build fortifications by raising the rate by 25 bps at the monetary policy committee meetings in October and December, and then pause and assess the situation with upcoming data.'
Ghosh also suggested that the rate hike cycle would be moderate, with cumulative increases of 50-75 bps, as it is driven by inflation normalization rather than an aggregate of price pressures. Gaura Sen Gupta, chief economist at IDFC First Bank, stated that the rate hike cycle could begin in October or December, with a higher probability of starting in October given the expected peak in the third fiscal quarter of 2027. She added that the September figure was 5.6 percent year-on-year, caused by food and fuel prices, as well as adverse base effects.
Meanwhile, MUFG expects the RBI to raise rates by 50 bps, 25 bps in December 2026 and February 2027. MUFG noted that it sees some risk that the RBI might conduct hikes of 75 bps in this cycle, which would bring the RBI repo rate to 5.75 percent by the end of the 2026/27 fiscal year. However, the report also warned of certain risks related to the RBI potentially being forced to accelerate rate hikes in the future, especially if credit growth management and ample liquidity conditions are handled inefficiently.
Funds received through non-resident deposits in foreign currency have given the RBI more scope to curb rupee depreciation, but this has also created its own challenges, namely managing rupee liquidity. MUFG emphasized that the most pressing task for the RBI is to use its set of tools to absorb this excess liquidity, which arose as a side effect of these currency inflows, and which currently exceeds 10 trillion Indian rupees. This occurs while credit growth in India accelerates, domestic demand and growth remain robust, fiscal policy is supportive, and inflation is projected to start rising in 2027 partly due to possible adverse weather conditions and high global oil prices.
According to SBI Research, the mobilized amount of $127 billion is almost equivalent to the funding deficit in the banking system. Ghosh concluded that the current surge will likely subside naturally due to strong credit demand, supported by equally strong GDP growth figures in the first quarter of 2027, and consequently, systemic liquidity is likely to stabilize by the end of the 2027 fiscal year.
