Source : INDIA TODAY NEWS
About 10 months ago, Reserve Bank of India (RBI) governor Sanjay Malhotra described the economy as being in a “rare Goldilocks period”. Growth was running near 8 per cent, inflation was projected at 2 per cent for the year and the repo rate had been cut by 125 basis points (bps) in a calendar year. Asked whether there was room for more, Malhotra had suggested policy rates were likely to stay low rather than high.
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Cut to October 7 and the same governor has announced the RBI’s first repo rate increase since February 2023. The RBI’s six-member Monetary Policy Committee (MPC) voted unanimously to raise the repo rate by 25 basis points to 5.5 per cent and shifted its stance from “neutral” to “calibrated tightening”. Malhotra said rate cuts were off the table in the near term and that the next move could only be a hike or a pause.
The distance between those two moments is the story of this year. In between came a war. On February 28, US-Israeli strikes on Iran set off a conflict that effectively closed the Strait of Hormuz, through which India sources most of the crude oil that meets 88 per cent of its requirements.
Brent, which had been trading at $78 a barrel the day before, surged past $125 by late April. A ceasefire in April and an interim US-Iran agreement on June 17 brought it back down to $73 by the end of June. Then, hostilities resumed in late August and Brent topped $96 in early September.
Through all of it, the rupee has been the worst-performing currency in Asia, losing about 6 per cent since the conflict began and trading at 96.54 to the dollar on the morning of the decision, not far from its all-time low.
The headline number—25 basis points—was widely expected. What markets had not priced in was the change in the RBI’s stance. The benchmark 10-year bond yield rose six basis points after the announcement. Upasna Bhardwaj, chief economist at Kotak Mahindra Bank, called the stance shift a surprise, pencilling in a further 25-50 basis points of tightening. DBS Bank’s senior economist and executive director Radhika Rao read the move as the RBI choosing to protect its inflation credibility before the risks took hold.
The phrase “calibrated tightening” is doing most of the work in this policy. It is not a declaration of a hiking cycle. It is a declaration that the easing cycle is over. To understand why the RBI moved now rather than in December, look at its own forecasts. Consumer price inflation had stayed below the 4 per cent target for 16 consecutive months before turning in June. It then climbed to 4.5 per cent in July and 4.8 per cent in August, with core inflation, which strips out food and fuel, rising to 4.2 per cent.
The central bank raised its full-year inflation projection to 5.2 per cent from 5 per cent, and the quarterly path is more telling than the average: 4.9 per cent in July-September, 6 per cent in October-December, and 5.7 per cent in January-March.
Six per cent is the upper edge of the tolerance band the RBI is bound to by law. A central bank cannot publish a forecast that touches its own ceiling and keep a neutral stance without inviting questions about whether it intends to meet its mandate. Seen that way, the stance change is partly an act of self-protection. If inflation reaches 6 per cent in the December quarter, the RBI will be able to say it acted first.
The arithmetic also explains why most economists expect more rate hikes. With the repo rate at 5.5 per cent and inflation forecast between 5.2 per cent and 6 per cent over the coming quarters, the real policy rate, adjusted for expected inflation, is close to zero. Past RBI estimates have put the neutral real rate at around 0.8 to 1 per cent. Even partly closing that gap would take the repo rate to 5.75 or 6 per cent, which is where market expectations for a terminal rate now sit. Analysts polled after the decision broadly expect another 25 basis point increase at the December meeting.
Yet the MPC itself is not of one mind about the road ahead. The vote to raise the rate was 6-0. The vote to change the stance was 4-2. Two members were willing to raise the price of money as insurance against an oil shock, but declined to sign on to a tightening bias. The minutes of the meeting, due in a fortnight, will show who dissented and why.
Until then, the split is the clearest signal that “calibrated” was chosen with care: a majority of the MPC sees further tightening as likely, a minority sees today’s hike as sufficient, and both sides agree that December’s data, not October’s decision, will settle the matter.
The decision cannot be read through domestic inflation alone. It is, in part, a currency decision. Foreign institutional investors have withdrawn more than Rs 2 lakh crore from Indian markets in 2026. The rupee crossed 92 to the dollar in early March, 95 by the end of that month and 96 in May—each time on a fresh spike in crude prices. The sequence is self-reinforcing: pricier crude oil widens the import bill, which weakens the rupee, which further raises the rupee cost of every imported barrel. This feeds back into inflation and into pressure on the RBI.
A higher repo rate works on this loop through two channels. It restores part of the gap between Indian and US interest rates that narrowed when the US Federal Reserve raised its own rates on September 16, with another increase signalled before the year-end. That keeps rupee assets from losing further appeal to the capital that has been leaving. And it signals intent. There is a precedent: in August 2022, after oil spiked on the war in Europe, the RBI raised rates by 50 basis points, and State Bank of India’s chief economist read the move as using interest rates to defend the rupee. The October 7 hike has the same DNA at a smaller dose.
The smaller dose matters. The RBI has been selling dollars from its reserves throughout the year to slow down the rupee’s decline, and it has kept liquidity conditions from tightening sharply even as it raised the policy rate. Economists describe this as keeping the price of money higher while leaving its availability intact so that credit continues to flow to a fast-growing economy. It also preserves ammunition. A large rate move now would spend room the RBI may need if the Strait of Hormuz closes again.
And it may. The oil assumption underlying the 5.2 per cent inflation forecast is the forecast’s weakest point, because the assumption has been wrong, in both directions, every quarter this year. Brent fell more than $50 between late April and late June on diplomacy alone, then rebounded sharply when strikes resumed.
Goldman Sachs has warned that a prolonged closure of the Strait of Hormuz could keep Brent above $100 for the rest of the year while projecting prices near $80 if the situation stabilises. The RBI is setting policy against a variable it cannot forecast with confidence more than a few weeks ahead. That is the honest reason governor Malhotra would commit only to a rate hike or a pause.
What makes India’s position distinctive is that it is both the most exposed and the best cushioned of the major economies confronting this shock. The exposure is structural: no other large economy combines near-total dependence on imported crude routed through Hormuz, a current-account deficit, and a heavy sensitivity to portfolio flows. The Federal Reserve, the European Central Bank and the Bank of Japan are all contending with energy-driven inflation. None of them is contending with a balance of payments loop at the same time.
The cushion is growth. The economy expanded 7.8 per cent in the April-June quarter, well above the RBI’s own expectation, and the central bank has raised its full-year forecast to 7.1 per cent from 6.7 per cent, with the second quarter now seen at 7.2 per cent and the third at 6.9 per cent. Few major economies have that much room to absorb 50-75 basis points of tightening without triggering a recession debate.
Europe is raising rates into growth of under 1 per cent. The Bank of England held in September on a 6-3 vote, with three members wanting a hike to pre-empt second-round effects. The Federal Reserve raised rates in September for the first time since 2023, citing a resilient economy as room to act, and is now tightening alongside India. India’s trade-off is between fighting inflation and slowing exceptionally strong growth, and those are not equivalent risks.
India’s closest parallels are in Asia. South Korea has been tightening with resilient growth, but with the added burden of surging property prices and household debt. Singapore manages imported inflation by letting its currency appreciate, a path India cannot take without damaging exporters. Brazil, which spent years at very high rates, is cutting. The lesson of the comparison is not that everyone must hike. It is that each central bank’s response is set by its starting point, and India’s starting point of moderate rates, strong growth and a weak currency points towards further, gradual tightening unless oil retreats.
Three paths lead to the December meeting. If Hormuz settles and Brent drifts back towards $80, the RBI can pause at 5.5 per cent with its tightening bias intact and the rupee likely to recover ground. If the standoff grinds on with oil between $90 and $105 per barrel, the base case among economists is another 25 basis points and heavy intervention in the currency market.
If the US-Iran conflict escalates and Brent returns to $115 or higher, the playbook of 2013 and 2022 comes back: larger hikes, currency measures and a cut to the growth forecast. The asymmetry is what guides the RBI. It loses little by pausing in the first scenario and loses credibility badly if it under-reacts in the third.
That is the real significance of the October 7 rate hike. The RBI has not declared war on inflation. It has declared that its economy is strong enough to confront an external shock rather than look through it, and that the rupee and the inflation forecast left it with no comfortable alternative.
Rates can stop an oil shock from becoming an expectations shock, and from becoming a currency crisis. But whether a single calibrated hike is enough to do that will be decided not at the RBI headquarters in Mumbai but the Strait of Hormuz, and the committee that voted 4-2 on its own stance knows it.
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SOURCE :- TIMES OF INDIA
