UPSC Darpan

EconomyGS38 October 2026

RBI Raises Repo Rate to 5.50%, Its First Hike Since February 2023

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The news

Mumbai. Moving from forecast to decision, the Monetary Policy Committee on October 7 unanimously raised the repo rate, at which the RBI lends overnight to banks, by 25 basis points to 5.50%, its first hike since February 2023. Per the RBI’s resolution, the Standing Deposit Facility rate is now 5.25% and the Marginal Standing Facility rate and Bank Rate 5.75%. The stance moved from “neutral” to “calibrated tightening” by 4–2; Nagesh Kumar and Ram Singh wanted it kept neutral. Governor Sanjay Malhotra said rate cuts are “off the table in the near term”. The RBI raised its 2026-27 growth forecast to 7.1% from 6.7% after first-quarter growth of 7.8%, and projects inflation at 5.2%, averaging almost 5.8% over the next three quarters. It named the West Asia conflict, crude volatility, a deficient monsoon and El Niño.

The chain in one line: Crude rises and a weak monsoon meets El Niño → inflation crosses 4% while growth hits 7.8% → price pressure spreads into core items → MPC hikes and shifts to calibrated tightening

Static syllabus linkage

  1. The RBI Act fixes who sets the target and who hits it. Section 45ZA of the RBI Act, 1934, inserted in 2016, lets the Centre, in consultation with the RBI, set the inflation target every five years: CPI inflation of 4%, band 2–6%. Section 45ZB creates a six-member MPC: the Governor (chair), a Deputy Governor, one RBI officer and three external members appointed by the Centre. Under Section 45ZI, the Governor has a casting vote in a tie.
  2. The LAF corridor keeps the overnight rate near the repo. Banks short of cash borrow from the RBI at the MSF rate, the ceiling; banks with spare cash park it at the SDF rate, the floor, without collateral. So the call rate stays near the repo, and moving the repo moves the whole corridor.

Why UPSC loves this

  1. Inflation versus growth is a fixed GS3 question. The syllabus covers “growth, development and employment”; a supply-shock hike tests how inflation targeting works.

Prelims nuggets

  • The MPC was created by amending the RBI Act, 1934 through the Finance Act, 2016.
  • The inflation target is set by the Central Government in consultation with the RBI, once every five years.
  • The Standing Deposit Facility is the floor of the LAF corridor and absorbs liquidity without collateral; the MSF is the ceiling.
  • External-benchmark-linked loans reset with the repo; MCLR-linked loans move only with banks’ cost of funds.

Analysis

  1. A hike cannot make oil or rain cheaper, but it can stop the second round. Higher rates do not lower crude prices. They can stop a supply shock spreading into wages and other prices. CPI items rising faster than 4% grew from 65 in January to 110 in August, per the IE. Crisil’s Dharmakirti Joshi notes that inflation broadens when supply shocks meet strong demand.
  2. Lens — Short-term relief and long-term reform: the stance is the real decision. A 25 bp hike is small; calibrated tightening tells markets cuts are over, so they adjust now. The ET editorial urges frontloading, recalling that the RBI fell behind the curve after the Ukraine shock. A thoughtful officer would accept slower credit now over a costlier fight with entrenched 6% inflation later.
  3. Global yields leave less room than the inflation number suggests. Joshi notes the India–US ten-year bond spread has narrowed to about 200 bp from over 400, so foreign money leaves and a weaker rupee raises import prices. The counter-view: fuel taxes and food stocks, which the government controls, act faster on these prices.

Possible Mains question

“Monetary policy cannot cure a supply shock, but it can stop it spreading.” Critically examine with reference to the RBI’s latest policy. (15 marks, 250 words)

Model approach

  1. Directive — Critically examine. Test the claim from both sides; give a judgement.
  2. Introduction — a hike amid supply-driven inflation. Repo 5.50%, calibrated tightening, CPI forecast 5.2%.
  3. Rates cannot lower crude but can anchor expectations. Value addition: items above 4% inflation rose from 65 to 110.
  4. Strong growth and narrow yield spreads justify acting early. Flowchart: oil and monsoon shock → headline CPI → expectations → core CPI → repo hike.
  5. Fiscal tools must carry part of the load. Fuel taxes and food stocks act faster.
  6. Conclusion — coordinated tightening. Hike now, with fiscal supply management alongside.

Administrator's brainstorm

As head of an MSME lending cell in a public sector bank, how would you respond to the hike?

Repo-linked loans will reprice within the quarter, so I would identify units whose instalments now strain thin cash flows. For sound businesses I would offer a longer tenure rather than let accounts slip into stress.