The Reserve Bank of India could return to a rate hiking cycle during the second half of financial year 2026 to 2027, according to an assessment by Union Bank of India. The bank expects the policy repo rate to rise from the current 5.25 percent to a range of 5.75 percent to 6 percent if inflationary pressures and excess liquidity remain elevated.
The forecast does not represent an official decision by the Reserve Bank of India. Instead, it is Union Bank of India's assessment of how monetary policy could evolve as economic conditions change. According to the report, the next rate hiking cycle could begin as early as December 2026. The bank expects two or three increases of 25 basis points each, which would take the repo rate towards the projected range.
The repo rate is the interest rate at which the RBI lends short term funds to commercial banks against eligible securities. Changes in the policy rate can influence borrowing costs across the financial system, including interest rates on loans and the returns offered on some deposits.
The RBI's current policy repo rate stands at 5.25 percent. The central bank has maintained the rate at that level while monitoring growth, inflation, liquidity and external economic risks.
Union Bank's latest projection comes against the backdrop of a significant increase in liquidity within India's banking system. Large foreign currency inflows have resulted in a substantial amount of rupee liquidity entering the financial system.
The increase is linked to a special foreign currency deposit programme that attracted strong inflows from overseas. Reuters reported that the programme brought in around 127.23 billion dollars through FCNR(B) deposits, contributing to a record increase in system liquidity. Total foreign exchange inflows through related channels were considerably higher.
The surge in foreign currency inflows creates a policy challenge for the RBI. While stronger inflows can improve India's external financial position and support foreign exchange reserves, the conversion of those funds into rupees can increase domestic liquidity.
Excess liquidity can push short term market interest rates lower and make financial conditions easier. However, if liquidity remains significantly above the level required by the banking system, it can also complicate monetary policy management and potentially add to inflationary pressures.
Reuters recently reported that India's banking system was facing a liquidity surplus of around 9.7 trillion rupees following the large inflows associated with the foreign currency deposit programme. The RBI is considering several options for absorbing some of this liquidity.
Among the possible tools are variable rate reverse repo operations, foreign exchange sell and buy swaps, government bond sales and adjustments to the cash reserve ratio. Each measure has different implications for banks, financial markets and the broader economy.
Indian banks have reportedly favoured foreign exchange sell and buy swaps as one possible method of reducing surplus rupee liquidity. Such transactions could allow the RBI to absorb liquidity without creating the same impact across other financial assets as some alternative measures.
Union Bank's projection suggests that liquidity management may become increasingly important for monetary policy during the second half of FY27.
The bank expects core liquidity to increase substantially because of foreign exchange inflows. Its assessment indicated that core liquidity had already increased from approximately Rs 4.82 lakh crore in mid June to around Rs 8.05 lakh crore by mid August. Under an illustrative scenario, it could rise further to approximately Rs 14.17 lakh crore by September 11.
This situation presents the RBI with a delicate policy challenge. The central bank must prevent excessive liquidity from creating unwanted inflationary pressure while also avoiding unnecessary tightening that could weaken economic growth.
India's economic growth has remained relatively strong. Recent data showed that real GDP expanded by 7.8 percent in the April to June quarter of FY27, exceeding market expectations. The strong growth performance has encouraged economists to reassess India's overall growth outlook.
Strong growth gives the RBI more flexibility to focus on inflation and liquidity management if price pressures begin to increase. At the same time, policymakers must consider external risks, including higher crude oil prices, geopolitical tensions, currency movements and changes in global financial conditions.
Inflation remains another important factor behind expectations of future rate increases. Higher liquidity, stronger domestic demand and external cost pressures could create challenges for the RBI if inflation moves persistently above its target.
Union Bank's forecast therefore combines several factors rather than relying on a single economic indicator. The bank expects strong growth, increasing inflation risks, excess liquidity and tighter global financial conditions to create an environment in which rate hikes could return.
The expected timing is also significant. Union Bank believes December could be the more likely starting point for a new rate hiking cycle in its base-case scenario. This would give the RBI time to assess the impact of its liquidity management measures and obtain additional information on inflation and growth before making a significant policy shift.
However, the December timing is only a forecast and should not be interpreted as a confirmed RBI policy decision.
The Monetary Policy Committee will ultimately decide the direction of the policy repo rate based on incoming economic data and its assessment of inflation and growth risks.
If the repo rate eventually rises towards 5.75 percent or 6 percent, the impact could be felt across the banking and financial sectors.
Borrowers with floating rate loans could face higher interest costs if banks pass on the increase through their lending rates. Home loan, personal loan and business loan borrowers could therefore see higher monthly payments or longer repayment periods, depending on how their individual loan agreements are structured.
Banks could also face changes in their funding costs and lending demand. A higher policy rate generally makes borrowing more expensive and can moderate credit growth over time.
Depositors, on the other hand, could potentially benefit if banks increase deposit rates in response to tighter monetary conditions. The actual impact would depend on how individual banks adjust their lending and deposit rates.
For financial markets, expectations of higher interest rates can also influence government bond yields, equity valuations and currency movements.
A higher rate environment can make fixed income instruments more attractive to some investors, while higher borrowing costs can put pressure on companies that depend heavily on debt financing.
The RBI's liquidity management strategy will therefore be closely watched alongside its interest rate decisions.
The central bank currently has several tools available to manage liquidity without immediately changing the repo rate. These include variable rate reverse repo operations and foreign exchange operations. It can also consider changes to the cash reserve ratio and open market operations depending on market conditions.
The choice of instrument will depend on the RBI's assessment of the nature and persistence of the liquidity surplus.
If the surplus is considered temporary, the central bank may prefer short term operations. If excess liquidity becomes more persistent, longer duration measures could become more relevant.
The situation is particularly important because the foreign currency inflows have strengthened India's external buffers while simultaneously creating domestic liquidity management challenges.
The large inflows have also helped India's foreign exchange reserves reach record levels. Reuters reported that India's foreign exchange reserves had risen to approximately 729.33 billion dollars by August 21 following the surge in inflows.
However, these inflows also create future liabilities because much of the foreign currency deposited through the programme is subject to maturity periods. The RBI therefore needs to balance the benefits of stronger reserves against the liquidity and balance sheet implications of the inflows.
For the Indian economy, the key question will be whether inflation remains manageable while growth continues at a strong pace.
If growth remains robust and inflationary pressures increase, the RBI could face greater pressure to tighten monetary conditions.
If inflation remains under control, the central bank may have less immediate need to raise rates, particularly if economic risks increase.
This makes the Union Bank forecast an important market indicator but not a predetermined policy outcome.
The bank's projection of a 5.75 to 6 percent repo rate in FY27 reflects its current assessment of the economic environment. Future policy decisions will depend on inflation data, growth numbers, liquidity conditions, global financial developments and the RBI's assessment of risks.
For borrowers and investors, the latest forecast is therefore a signal to monitor interest rate expectations rather than an announcement of an immediate rate increase.
The RBI has not announced a decision to raise the repo rate to 6 percent. The current policy rate remains 5.25 percent, while Union Bank expects possible increases later in FY27 if economic and inflation conditions develop as anticipated.
As India enters the next phase of FY27, liquidity management and inflation will remain central to the monetary policy debate. The coming policy meetings will provide greater clarity on whether the RBI considers the current liquidity surplus temporary or persistent and whether rate increases are necessary to maintain price stability.