RBI Raises Repo Rate and Signals More Hikes Amid Currency and Inflation Concerns

In a move anticipated by many, the Reserve Bank of India (RBI) raised the repo rate by 25 basis points during its latest policy review. However, what caught some analysts off guard was the RBI’s shift in stance, signaling that additional rate hikes are likely in the near future. The central bank’s focus remains on curbing rising inflation amid sustained economic growth, but beneath the surface, currency stability has emerged as a critical concern.

Inflation in India has been edging closer to, or even surpassing, the upper threshold of the RBI’s tolerance band of 6 percent. This elevated inflationary pressure is expected to persist for the next two to three quarters. Notably, inflation expectations have risen sharply, hovering around 10 percent for the coming year. Much of this inflation surge is driven by food prices, influenced by a deficient monsoon season and ongoing geopolitical tensions. While supply-side factors typically fall outside the direct control of the central bank, the RBI must intervene when inflationary pressures begin to extend beyond immediate price increases and start affecting finished goods and wages, potentially triggering a wage-price spiral.

Beyond inflation and growth metrics, the RBI is paying close attention to currency dynamics. India’s trade figures highlight a significant imbalance: annual merchandise imports stand at $830 billion, while exports are $476 billion. Given that the country imports many finished goods and essential commodities such as oil, a depreciating rupee can accelerate inflation through higher import costs. Currency stability also plays a pivotal role in attracting foreign capital inflows, which help finance the country’s structural current account deficit. This deficit arises because net dollar inflows from exports and remittances are consistently lower than the outflows from imports and outward payments.

Recent currency movements have raised concerns. The rupee has depreciated about 4.7 percent in 2025 and around 7 percent year-to-date in 2026. This depreciation discourages foreign portfolio investments, as returns can be undermined by currency losses. The RBI has repeatedly flagged external risks since its policy meeting in April 2026 but has yet to fully convince currency markets with its policy measures.

One tool the RBI has employed is the foreign currency non-resident (bank) or FCNR (B) deposits. These deposits are essentially borrowings that come with an equivalent liability through a large outstanding short-forward book, which had already been $103 billion before FCNR deposits were mobilized. By August, this forward book increased to $200 billion. As a result, the reserve accretion from FCNR deposits provides only temporary liquidity, and the rupee remains near its lows from May 2026.

The RBI’s approach differs from 2013, when currency appreciation of 6 to 7 percent was achieved partly due to favorable global conditions and manageable capital flows. Currently, capital flows have been challenging for two years, and the RBI bears the cost of the dollar-rupee forex swap facility. The presence of surplus liquidity, partly fueled by FCNR deposits, has created distortions in the credit market. Banks have less pressure to raise deposit rates amid repo rate hikes, while lending rates rise, causing uneven transmission.

Credit growth has been steady, with year-to-date figures from April to August showing 4.8 percent growth, translating to an annualized rate of 11 to 12 percent. Earlier in the year, surges in inflation-driven working capital demand caused credit growth spikes, but these have since normalized. The RBI governor has acknowledged that excess liquidity has led to rate distortions, particularly between deposit and lending rates.

Despite these challenges, the RBI refrained from announcing new liquidity tightening measures. Tools like longer variable rate reverse repo operations, open market sales, and sell-buy swaps have been tested but have not fully resolved the situation. The RBI may be allowing liquidity conditions to adjust naturally before implementing further steps. An incremental increase in the cash reserve ratio remains an option yet to be explored.

The decision to limit the repo rate hike to 25 basis points, rather than a more aggressive 50 basis points, likely reflects concerns about the potential for further market distortions in a surplus liquidity environment. However, with external risks and currency volatility rising, the RBI may have to consider more frequent or larger rate hikes going forward.

Comparing RBI reserves to outstanding liabilities shows the challenge: while FCNR deposits total $133 billion, reserve accretion from June to October 2026 has been $63 billion, with the difference spent on unwinding forward contracts and swaps. Other central banks in emerging markets have been hiking rates aggressively in response to similar pressures. Indonesia raised rates by 100 basis points between May and June, South Korea by 50 basis points, the Philippines by 75 basis points, South Africa by 50 basis points, Australia by 100 basis points, and New Zealand by 50 basis points.

These global moves underscore the need for the RBI to balance inflation control, currency stabilization, and financial market stability. Currency movements reflect underlying economic fundamentals and serve as a feedback mechanism for monetary credibility. The RBI may need to accelerate rate hikes, potentially at 50 basis points at a time, instead of waiting for longer intervals. An off-cycle monetary policy meeting, similar to the one on May 4, 2022, could be on the horizon if market conditions demand prompt action.

Anitha Rangan, Chief Economist at RBL Bank, authored this analysis published on October 12, 2026.