The Reserve Bank of India’s (RBI) focus on controlling inflation could increase the possibility of a policy rate hike at its October meeting, economists said. The central bank’s efforts to absorb excess liquidity are also expected to keep short-term interest rates firm as markets factor in the possibility of further rate increases.
RBI Steps Up Liquidity Absorption
Radhika Rao, Senior Economist and Executive Director at DBS Bank, said the recent decline in benchmark oil prices helped stabilise Indian rupee assets, although higher US Treasury yields could offset some of that support.
She noted that the USD/INR pair had closed around the mid-95 level but could resume its upward movement, prompting strong intervention from the central bank.
Liquidity conditions have tightened significantly following the RBI’s continued efforts to absorb surplus funds from the financial system. These measures have included open market operations (OMOs), Variable Rate Reverse Repo (VRRR) auctions and short-tenor sell-buy swaps.
Tax outflows, seasonal currency leakage and occasional foreign-exchange sales have also contributed to reducing excess liquidity.
Surplus Liquidity Falls Below Rs 5 Lakh Crore
The liquidity surplus declined to below Rs 5 lakh crore last week, compared with a peak of around Rs 10–11 lakh crore. Economists said the reduction could improve monetary policy transmission and bring the weighted average call rate closer to the repo rate.
Rao also pointed out that liquidity and core inflation have historically shown a modest positive relationship, indicating that prolonged excess liquidity can have implications for inflation.
Economists Expect Two Rate Hikes
Pranjul Bhandari, Chief India Economist and Strategist at HSBC Global Investment Research, said the firm continues to expect two 25-basis-point rate hikes, one each at the October and December policy meetings.
If implemented, the two increases would take the repo rate to 5.75 per cent. Bhandari also expects the RBI to provide greater clarity on further measures to remove excess liquidity during the October meeting.
Excess liquidity can contribute to inflationary pressures and may also create financial stability concerns if banks become overly dependent on abundant funding conditions.
RBI Has Several Liquidity Tools
The RBI has already used measures including VRRR auctions, OMO sales and foreign-exchange swaps or spot sales to manage liquidity.
Further options include increasing the Cash Reserve Ratio (CRR) and issuing Market Stabilisation Scheme (MSS) securities. The choice and timing of additional measures will depend on the RBI’s assessment of liquidity, inflation and broader financial conditions.
Disclaimer: This article is based on economists’ views and market expectations available at the time of writing. Monetary policy decisions are taken by the RBI and may differ from these expectations. Readers should refer to official RBI announcements for confirmed policy decisions and rates.