Repo Rate - Better to keep the rate unchanged?

 Repo rate review: 

A catch 22 situation?

The fourth bi-monthly review meeting of the Monetary Policy Committee (MPC) of Reserve Bank of India (RBI) for the current financial year (FY 26-27) starts tomorrow.

What will be the decision of RBI MPC on repo rate? 

On the negative side, Crude Oil prices, an important factor to contribute imported inflation, are ruling above USD100 per barrel in the last three weeks. The other factor for increase in domestic prices due to imports, the Indian rupee, inspite of FCNR B inflows of USD 133 billion, continues to be weak with ₹96 mark breached quite often. The US FED raised its policy range rate by 25 basis points to 3.75-4.0% in Sep' 26, the first increase since 2023. (Incidentally, RBI also last raised the Repo rate in 2023 only). Net FPI outflows crossed USD4 billion in Sep' 26 reversing the positive trends in July and August 2026. US 10 year Treasury Bond yields are ruling at 5.25% (50 bps more than the ruling rate last month) and the difference in yields between Indian securities and US securities, an essential ingredient to encourage dollar inflows, has compressed further. The monsoon rainfall is in deficit with 43% of districts receiving deficit rain fall. The inflation is above the RBI MPC target rate of 4% for the last three months and recorded the highest at 4.82% in Aug' 26. (food inflation is at 5.95%). As per MPC's own forecast, the inflation is expected to peak at 5.9% in Q3.

On the positive side, the forex reserves, though declined by more than USD30 billion in the last two weeks, still gives adequate room for  comfort at USD748 billion. The factory output growth, based on new series of IIP clocked 8.0% in Aug' 26, with maximum growth reported from manufacturing and electricity generation. 

Comparing the two, no one will find fault with RBI MPC, if they decide to increase the repo rate at least moderately, by 25 bps, though there may be a debate, if they decide to keep the stance unchanged (neutral).

While I am in agreement with the general expectation that the repo rate might be increased by 25 bps, I am concerned about the transmission. Any financial decision is judged by bringing in the result that is  intended by such an action, rather than judging it based on its correctness in the current situation. 

Transmission has to happen across money market instruments, deposits and loans, if the decision on repo rate is to be deemed a success.

(i) Transmission to lending rates: The liquidity in the banking system is more than ₹7 lac cr. (if one reckons that ₹3.2 lac cr. sucked through VRRR on 07th and 11th Sep' 26 is due for redemption shortly). Majority of the liquidity in the system has been sourced, through FCNR B route, at interest rates ranging between 6.5-7.0%. The banks will be more eager to deploy them in the secured loan market at decent rates. With the domestic inflation already hitting the packets of a middle class person/common man, the banks may be hesitant to increase the lending rates on new loans, even if the repo rate is raised to bring immediate benefit on existing loans. There is another factor also, to not to increase the lending rates. The growth in deposits has doubled over the growth figures of the corresponding period last year. (₹40.76 lac cr. growth as against ₹20.41 lac cr. last year). The growth in deposits Y-o-Y is 17.3% as against a growth of 18.1% growth in credit. Hence the interest expenses have gone up equally or more than the interest income. This will put pressure on the net interest income, the main component that constitutes operating profit, unless the excess liquidity is deployed by way of loans.

(ii) Transmission to deposit rates: With so much of liquidity available, no banker would be interested in increasing deposit rates. In fact, raising deposit rates, that hit the bottom line straight, will be the last priority for bankers. It is even possible that some of the banks may look forward to reduce the deposit rates in the short term.

(iii) Transmission to money market instruments: 10 year G-Sec appear to have already factored the impending repo rate higher revision, as reflected by the 10-year G-Sec yield ruling at 7.2% levels. The yield may not come down, even if any increase in the repo rate may not push the yield still higher. In the above circumstances, any new issue by the government to borrow from the market, will have to be at higher coupon rate (including the treasury bills), if the repo rate is raised by 25 bps. This is bound to impact fiscal deficit forecast. The interest rate on CDs may not affect the banks, as they have surplus liquidity anyway. The interest rate on CPs may note affect the corporates, as well rated corporates will be tempted to avail cheaper interest rate loans by banks, flushed with liquidity. Even the overnight call rate may not follow the repo rate immediately, if the latter is increased.

Based on the above arguments, in my view, there is nothing wrong, if RBI MPC decides to pause the repo rate  and retain the monetary stance in its October meeting.

Regards

V. Viswanathan
CGM Retd. e-SBT

4th October 2026