A 25-basis-point repo rate hike is expected at the October 7 monetary policy.

With Brent near $100 a barrel, El Niño lifting food-price pressures and global financial conditions tightening, risks have shifted. That said, India's monetary-policy debate has changed materially since the August MPC. 

Some market participants now expect a 50-basis-point move, but the case is stronger for a calibrated 25-basis-point increase, accompanied by active liquidity management to ensure effective transmission, particularly with growth expected to slow in the second half of 2026–27.

The MPC is also expected to shift the policy stance to calibrated tightening alongside the start of the rate-hike cycle. With surplus liquidity still elevated, the change would reinforce the policy signal and improve transmission across money and credit markets, while retaining flexibility amid geopolitical uncertainty.

Domestic growth remains resilient: April–June 2026–27 GDP grew 7.8%, and high-frequency indicators suggest growth above 7% in July–September. However, the outlook remains delicately poised, with momentum likely to moderate in the second half on the El Niño impact, adverse base effects and fragilities in global growth. Some fault lines are also appearing in the US economy, particularly in softer labour-market data. There is still scope for 2026–27 growth to be revised closer to 7% from 6.7%.

More importantly, inflation is tracking above the MPC’s 5% full-year projection: August printed at 4.82%, and September is tracking near 6%, which could lead the RBI to raise its 2026–27 inflation forecast by 20–30 basis points to 5.2–5.3%.

Liquidity Choices
The harder question is liquidity, and active management through March 2027 will be critical for effective monetary policy transmission and to ensure that the weighted average call rate, or WACR, remains aligned with the repo rate.

Flexible tools remain preferable: VRRRs, calibrated OMO sales, foreign exchange sell-buy swaps and front-loaded Treasury-bill issuance. Given that durable liquidity tools such as OMOs and foreign exchange swaps have started to have distortionary impact on  markets (especially short term rates and forward premia), the objective needs to be calibrated absorption rather than elimination of the surplus.

Recent communication from the RBI Governor appears consistent with this approach. He indicated that part of the liquidity surplus would drain naturally and played down a CRR response. Eligible FCNR(B) deposits under the special window were exempted from CRR and SLR, so a large system-wide CRR increase soon afterwards could dilute that incentive.

Liquidity calculations argue against haste.

System liquidity may ease to around 1% of NDTL by end-March 2027 after currency leakage, CRR requirements linked to deposit growth, government cash balances, and $20 billion of foreign exchange sell-buy swaps reportedly already completed, and ₹2–2.5 trillion of OMO sales, of which ₹1 trillion has already been completed.

Another area of policy concern has been the limited efficacy of term VRRRs, a tool with low market impact. Banks require support for daily liquidity management, including continued evening and overnight VRRR operations, so longer-tenor commitments do not impair end-of-day flexibility. Term VRRR covenants could allow T+0 settlement on prepayment instead of the current T+1 settlement. Pricing should also provide a term premium, since overnight and term VRRRs now carry broadly similar rates. These changes could improve participation amid volatile liquidity.

Seasonality could absorb part of the surplus as currency demand, festive consumption and working-capital needs rise, strengthening the case for allowing natural drains before reaching for CRR.

Cycle Risks
The rate path will depend on three risks: the duration of the US-Iran conflict and its oil impact; the extent of Fed tightening; and the intensity of El Niño. If geopolitical tensions ease, the MPC cycle could remain around 50–75 basis points; a prolonged oil shock could stretch it towards 100–125 basis points. A longer Fed cycle would also increase pressure for an elongated rate-hike cycle to follow the Fed.

Rupee pressure also matters. With the Federal Reserve resuming hikes, the RBI is expected to follow the Fed more closely in this cycle to preserve an attractive interest-rate differential and support interest-rate-sensitive capital flows when global bond yields are at multi-decade highs. This differs from 2022, when the RBI matched only around half of the Fed's cumulative tightening amid lower domestic inflation and a more favourable liquidity backdrop.

A CRR hike is not the base case, especially after the Governor's comments. However, if sustained foreign exchange swaps and OMO sales create distortions across currency and bond markets, a short-term CRR hike for the system, rather than an ICRR-type instrument, could become a pragmatic option. Any such increase could be clearly time-bound, perhaps for two to three months, with a defined exit strategy.

On balance, the October MPC is expected to begin rate-hike cycle, with 75 basis points as the baseline and the repo rate reaching 6% by end-March 2027. While some participants see a 50-basis-point move upfront, a calibrated path backed by liquidity management remains preferable. The liquidity priority remains flexible tools first and a stronger term-VRRR framework, with CRR reserved as a temporary last resort if other durable tools create distortions.

* Views are personal.