Rate hike sends a hawkish signal
The RBI’s October monetary policy communication was more consistent than its August messaging, according to SBI Research. The formal policy resolution, the Governor’s statement and the Monetary Policy Committee (MPC) minutes conveyed a broadly aligned message on the need to address inflation risks.
All six MPC members voted in favour of the 25-basis-point repo rate increase to 5.50%. The policy resolution adopted a hawkish tone, stating that inflation was no longer benign and that near-term policy choices were increasingly restricted to a rate hike or a pause.
However, the committee was not unanimous on the broader policy stance. While all six members supported the rate increase, only four backed the shift to calibrated tightening. Two members preferred retaining a neutral stance.
Against this backdrop, SBI Research questioned whether the liquidity injection was consistent with the RBI’s stated policy direction.
Why the liquidity injection matters
Liquidity operations influence the amount of funds available to banks and help determine short-term money-market rates. Injecting liquidity through repo auctions provides funds to the banking system, whereas liquidity withdrawal operations work in the opposite direction.
SBI Research noted that the RBI was pursuing calibrated liquidity tightening through measures including open market operations (OMOs) and variable rate reverse repo (VRRR) operations, while maintaining daily cash reserve requirements linked to 99% of the prescribed requirement, as described in the report.
ALSO READ: Rupee gains 1.9% in a week, closes at 94.71: Is RBI’s currency defence finally working?
The subsequent injection of ₹2.5 lakh crore, the report argued, appeared inconsistent with that approach. It raised the question of whether the RBI was moving from calibrated tightening towards a more moderate form of tightening.
The report acknowledged that concerns about financial stability could have influenced the central bank’s actions. However, it argued that simultaneous liquidity injections and withdrawals could send conflicting signals to financial markets.
What it means for bond investors
SBI Research does not expect Indian government bond yields to decline significantly, with yields at the higher end around 7.6%. It also highlighted elevated crude oil prices and the possibility of a rebound in US Treasury yields as factors that could keep domestic borrowing costs under pressure.
The report placed the India-US yield spread at around 250 basis points and said it was moving towards normalisation.
SBI Research recommended widening the Liquidity Adjustment Facility (LAF) corridor, arguing that it could act as an automatic stabiliser during uncertain periods.
DO READ: RBI broadens Rupee defence beyond dollar sales, turns to tighter monetary conditions: Report
What RBI MPC members said
In its monthly minutes, RBI Monetary Policy Committee (MPC) signalled that further rate hikes may be needed to contain inflation but cautioned against aggressive tightening that could hurt economic growth, minutes released on Wednesday showed. The RBI unanimously raised the repo rate by 25 basis points to 5.50% earlier this month and shifted its stance to calibrated tightening.
Retail inflation rose to 5.54% in September, nearing the RBI’s 6% tolerance ceiling, amid higher oil and food prices. Deputy Governor Poonam Gupta warned that additional hikes may be necessary to anchor inflation expectations, while some MPC members favoured gradual increases to protect growth.
The RBI raised its inflation forecast for the current financial year to 5.2% from 5% and projected average inflation of 6% for October-December. While some policymakers supported pre-emptive action, others warned that rapid rate increases could weaken demand. Economists remain divided, with forecasts ranging from two to three additional hikes in the current cycle.
DON'T MISS: BT Explainer: Strong GDP, weak rupee: Why India cannot stop its currency from falling