On Thursday (October 8), during the European session, the US dollar rose slightly against the Indian rupee, currently trading around 96.77. The Reserve Bank of India (RBI) has shifted to a hawkish stance, but why has the rupee failed to gain sustained support? A report by Charlie Lay of Commerzbank states that the RBI has restarted its tightening cycle, raising the repo rate by 25 basis points to 5.50% and adopting a "calibrated tightening" stance.

The Reserve Bank of India unanimously raised interest rates by 25 basis points to 5.50%, the first increase in nearly four years.

The Reserve Bank of India (RBI) unanimously raised its repo rate by 25 basis points to 5.50%, its first rate hike in nearly four years, and shifted its stance from neutral to “calibrated tightening” by a 4-2 vote. This rate hike was primarily a precautionary measure. While the RBI still believes demand-side inflationary pressures are limited, it noted signs of rising inflation expectations and broader price pressures amid rising food and energy costs. The policy bias has clearly shifted to a more hawkish stance, although the RBI emphasized that calibrated tightening does not mean a predetermined sequence of rate hikes. Instead, the RBI will rely on data. The next move will be either a rate hike or a pause. Clearly, a near-term rate cut is no longer on the table. The RBI also raised its CPI forecast for fiscal year 2026-27 from 5.0% to 5.2%, expecting inflation to reach 6.0% in the fourth quarter of 2026, at the upper end of the RBI's 2%-6% target range.

The policy shift is marginally beneficial to the rupee, but the dollar still rose against the rupee.

The policy shift was marginally positive for the rupee, as higher interest rates and the prospect of further tightening improved India's relative interest rate differentials and demonstrated the Reserve Bank of India's (RBI) determination to curb inflation. However, the dollar rose against the rupee after the decision, as the 25-basis-point rate hike was largely priced in, and the policy guidance was not significantly more aggressive than expected. This reaction suggests that despite the RBI's shift to a hawkish stance, the market had already priced in the rate hike, and broader drivers—oil prices, US Treasury yields, the dollar, and portfolio flows—continue to dominate the rupee's movements.

Oil prices, US Treasury yields, the US dollar, and portfolio flows remain key drivers in the near term.

Lay expects oil prices, US Treasury yields, the US dollar, and portfolio flows to remain key drivers in the near term. These external factors may have a greater impact on the rupee than the Reserve Bank of India's (RBI) policy shift. Rising oil prices push up Indian inflation and the trade deficit through import costs, putting downward pressure on the rupee; high US Treasury yields attract funds to dollar assets, suppressing emerging market currencies; a stronger dollar further suppresses the rupee; and changes in portfolio flows directly affect the rupee's supply and demand. While the RBI's interest rate hikes may marginally benefit the rupee, they are unlikely to offset these external pressures.

Inflation forecasts have been revised upward to 5.2%, with a projected 6.0% for the fourth quarter.

The Reserve Bank of India (RBI) has raised its CPI forecast for fiscal year 2026-27 to 5.2% from 5.0%, projecting inflation to reach 6.0% in the fourth quarter of 2026, at the upper end of its 2%-6% target range. This forecast reflects the RBI's growing concerns about the inflation outlook and supports a shift towards a more hawkish stance. Rising food and energy costs are the main sources of inflationary pressure, while demand-side pressures remain limited. If inflation reaches 6.0% as expected in the fourth quarter, the RBI may face further tightening pressure, especially given persistently high oil prices and a weakening rupee.

Summarize

The Reserve Bank of India (RBI) restarted its tightening cycle, raising interest rates by 25 basis points to 5.50%, the first such move in nearly four years, and shifting its stance to "calibrated tightening." This move is precautionary, aimed at curbing rising inflation expectations despite limited demand-side pressures. The RBI raised its CPI forecast for fiscal year 2026-27 to 5.2%, expecting it to reach 6.0% in the fourth quarter. The policy shift is marginally positive for the rupee, but the USD/RUB exchange rate still rose to around 96.77, as the rate hike was largely priced in and the guidance was not significantly more aggressive. Commerzbank expects oil prices, US Treasury yields, the US dollar, and portfolio flows to remain key drivers in the near term. Going forward, attention should be paid to Indian inflation data, subsequent RBI policy actions, oil price movements, US Treasury yields, and the performance of the US dollar. If inflation rises as expected and external pressures persist, the RBI may tighten further, but the rupee's movement will still be primarily driven by external factors. (USD/INR daily chart, source: EasyForex) At 16:09 Beijing time, the USD/INR exchange rate was 96.77/78.