The RBI has raised the repo rate by 25 basis points (bps), as expected, and, to the surprise of some, changed its stance by guiding for further hikes. While many policymakers talk about rising inflation and the need to fight it in the midst of healthy economic growth, there is an iceberg called “currency”, which has been stealing slowly.
Yes, inflationary pressures are increasing and may approach, or exceed the upper band of the 6 percent tolerance level and may remain there for two or three quarters. And, not to forget, inflation expectations are currently around 10 percent for a year. Yes, a lot of this is food, led by a poor monsoon, and, needless to say, geo-politics but the argument that the central bank cannot control supply-side factors is only up to the point when inflation is first order or direct inflation.
When the impact of rising prices begins to be included in the second order or finished goods and then wages, risking a wage-price spiral, central banks must step in.
But is it just inflation and growth? Why is currency important? India’s annual merchandise imports (last 12 months) were $830 billion and exports $476 billion. As we import more finished goods and non-discretionary goods including oil, the pass through from a depreciating currency can be faster. And that links inflation to currency. In addition, currency stability is a key barometer for attracting capital flows.
In the scenario of a large currency depreciation – as in the case of India 4.7 percent in 2025, 7 percent YTD (year-to-date) – foreign portfolio investment can remain elusive, because the return has been eroded to the extent of the depreciation of the rupee. Since India has a structural current account deficit (net dollar inflows, including exports and remittances, are lower than outflows from imports and outgoing payments), which has been financed by capital flows, eroding capital flows is a fundamental challenge.
Temporary liquidity
RBI in its policy emphasized that external risk is a problem and it has been done since April 2026 policy. But the policy measures of RBI have not convinced the currency market. Why?
First, non-resident foreign currency (bank) – or FCNR (B) – deposit is a borrower, And this loan comes with the same responsibility in terms of short-forward books outstanding. RBI already had a short-forward book of $103 billion before FCNR. Therefore, the accretion of FCNR to reserves is only temporary liquidity, which is only a balloon of repayment obligations. In August, the book advanced to $200 billion. The forward book set for FCNR just declined. In particular, the premise of currency depreciation to be implemented through FCNR is long overdue. The rupee is closer to its May 2026 low (96.96 per dollar).
Second, if it worked in 2013 (through 6-7 percent currency appreciation), why can’t it do the same? Capital flow is not a challenge. Global rates are very low, making the proposition easier. Liquidity is in deficit and RBI may raise marginal standing facility (MSF) rate before FCNR.
Capital flows have been a challenge for two years prior to the mobilization of FCNR deposits by banks under RBI’s special dollar-rupee forex swap facility. This time RBI has to bear all the swap charges. Preceded by excess liquidity, FCNR has created a flood of liquidity problems.
This flood can give banks a welcome breath and they do not need to rush to raise deposit rates during the repo increases when they like to go up in credit levels. But there may be some distortions. The RBI governor’s statement noted that excess liquidity has led to distortions in rates: “The transmission in the credit market reflects uneven movements in deposits and lending rates during July-August.” Noting that short-term rates have decreased while government securities yields have hardened, the RBI is least comfortable with the system’s high liquidity. If we look at the YTD credit growth (April to August) of 4.8 percent, an annual growth of 11-12 percent for the full year emerges.
The wave of 19-20 percent growth was led by inflationary working capital demand in May, which started to normalize. Beyond the FCNR, structural deposit growth can again be tested at higher credit deposit (CD) ratios.
Buy time
Then why didn’t RBI announce liquidity measures? Perhaps after testing most of the measures on the table – i.e. variable reverse repo rate (VRRR), open market operations (OMO) and buy-sell swaps, none of which are frictionless – the RBI is probably buying time for liquidity to open its doors. An incremental increase in the cash reserve ratio (CRR) is an unexplored option.
Why stop at 25, when maybe 50 bps is needed? In a scenario of excess liquidity, when transmission can be slow, a larger increase will only damage the credit and loan markets. But what other options are on the table when the external risk is high, driving the currency volatility more.
Note that the RBI’s reserves do not have a significant surplus – compared to the FCNR of $133 billion, the accretion of reserves from June 12 to October 2 is $63 billion. The $80 billion gap was implemented to eliminate existing forward books, buy-sell swaps, and price adjustments. Constructive obligation.
Global central banks hike – Indonesia hikes 100 bps (May-June) to defend currency. South Korea 50 bps, Philippines 75 bps, South Africa 50 bps, Australia 100 bps, New Zealand 50 bps — for currency, inflation or both.
Therefore, call for more. Yields and external rates give better signals. Currency defense is not only about interest rate differentials, but also about inflation and affecting financial stability. Currency is a mirror that reflects fundamentals and a valve of credibility that stabilizes imbalances.
RBI may have to hike at a pace of 50 bps and not have to wait another eight weeks. There are many slips twixt the cup and the lips. May 4, 2022 (off-cycle monetary policy committee meeting), may be on the phone.
Anitha Rangan, Chief Economist, RBL Bank
(The writer is Chief Economist, RBL Bank)
Published on October 12, 2026