Reserve Bank of India could raise its key repo rate to 5.75-6 per cent in the second half of FY27 as it seeks to contain excess banking liquidity and rising inflation amid strong economic growth, according to a report.
A report by Union Bank of India said it is expected to see two to three rate increases of 25 basis points each from the current 5.25 per cent with the rate hike cycle likely to begin in December under its base-case scenario.
“Rate hikes are back on the table for H2 FY27,” it said and added that December appeared to be the more likely starting point.
The outlook comes as foreign exchange inflows under the Reserve Bank of India’s special swap facility have surged to about $136 billion as of August 31 with $127.23 billion coming through FCNR(B) deposits and the remainder through overseas foreign currency borrowings and external commercial borrowings.
The report also highlighted that the inflows have sharply increased liquidity in the banking system, with core liquidity rising to 8.05 trillion rupees by mid-August from 4.82 trillion rupees in mid-June.
In an illustrative scenario, core liquidity could rise further to around 14.17 trillion rupees by September 11 making liquidity management a key policy challenge for the central bank.
“After getting dollar flows, now rupee liquidity management is key policy challenge for RBI,” according to the report.
In addition, UBI expects the RBI to announce measures to absorb excess liquidity before its October policy meeting. Short- and longer-term variable rate reverse repo operations (VRRR) and incremental cash reserve ratio (I-CRR) are among the measures it sees as having a high probability of being used.
The central bank could also consider bond sales and foreign exchange swaps to absorb liquidity, the report said.
Moreover, the PSU bank expects the RBI to initially rely on temporary measures that can be reversed as credit demand strengthens in the second half of FY27. Also, it estimates that a 50:50 mix of short-term VRRR and longer-duration measures could be used to absorb the projected surplus.
However, a rate hike in October cannot be ruled out if the US Federal Reserve raises rates in September and the RBI first absorbs excess liquidity through durable measures, the report said.
