The RBI Monetary Policy Committee (MPC) hiked the repo rate by 25bp to 5.5% for the first time since February 2023, accompanied by a change in the stance to ‘calibrated tightening’ from ‘neutral’. The call to hike was unanimous, while there were two dissents on the stance. The change in stance underscored the RBI MPC’s cautious view, reinforced by upward revisions to annual FY27 growth to 7.1% (+40bp vs Aug meeting) and inflation to 5.2% (+20bp vs Aug) forecasts. Policymakers acknowledged that cyclical inflation risks were no longer benign, but the Governor balanced the view by adding that as of now there were limited signs of supply side pressures getting embedded in pricing behaviour. Incipient pressures and a low base will push the quarterly average towards 6% in 3QFY27 (4Q26). Against the backdrop of elevated oil prices, tighter global financial conditions, and risks to food inflation from unfavourable weather, the MPC chose to reinforce inflation credibility before risks became entrenched.
The concurrently released Monetary Policy Report carried revisions in key economic assumptions – oil was revised up to $95bl for 2HFY from $85bl in the Apr26 update and USDINR seen at 95.0 vs 94.0. Updated inflationary expectations were steady for the 3-month horizon but continued to climb for the year ahead. The RBI refrained from announcing fresh liquidity measures, suggesting the existing toolkit of VRRR auctions, sell/buy FX swaps and open market operations will remain at play. On a related note, a tranche of 29-day INR 2trn VRRR auction will be conducted on Oct 8. Seasonal drivers like festive currency leakage, spot FX intervention, tax flows and government spending flows will also shape frictional dynamics. Liquidity normalisation is necessary to keep the call rate anchored to the repo rate, thereby strengthening policy transmission.
For markets, the combination of higher inflation forecasts and calibrated tightening should keep front-end rates biased higher. The policy shift is modestly constructive for the INR besides the RBI’s assertions that the rupee was undervalued on REER basis. Rupee nonetheless neared a record low/ USD yesterday, below 96.70 on a firm dollar, attracting intervention. On policy, considering Wed’s guidance, we expect 50bp more hikes in this cycle (total 75bp), taking the repo rate to 6.00%, with next moves in Dec26 and Feb27, effectively reversing part of the easing undertaken in 2025. This view rests on our revised inflation forecast at 5.3% yoy for FY27 from 4.9% currently and unchanged GDP forecast of 7.3% for FY27. Domestic inflation and growth trajectory, oil and US Fed’s rate outlook are key monitorables. The call for further hikes is also centered on the need to maintain sufficient real rates. If annual inflation averages 5.2-5.3% and the repo rate ends the year at 6.0-6.25%, the RBI will preserve a marginally positive real rate buffer. 
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