- RBI may raise repo rate by 25 basis points in October, with more hikes in FY27
- Persistent inflation and high crude prices support tighter monetary policy and higher yields
- Five-year G-Sec yields rose sharply in September, narrowing spread with 10-year securities
The Reserve Bank of India (RBI) could raise the repo rate by 25 basis points in October, with one or two more hikes possible later in FY27, potentially taking the benchmark rate to 5.75-6 per cent, according to a Union Bank of India report.
The report said persistent inflation risks, elevated crude oil prices and higher global bond yields could strengthen the case for tighter monetary policy and put further pressure on government securities (G-Sec) yields.
Government bonds remained under pressure in September as rising crude prices and global yields increased expectations of an RBI rate hike, the lender said in its report, cited by IANS.
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The report also pointed to increased domestic bond supply as another factor keeping yields elevated. RBI open market operation (OMO) sales, along with a higher share of long-tenor securities in the second half borrowing programme, added to the supply pressure despite lower overall government borrowing.
The impact was particularly pronounced in the five year government bond segment. According to the Union Bank, the five year G-Sec yield climbed 45 basis points during September, compared with a 24 basis point increase in the 10 year yield, narrowing the spread between the 10 year and five year securities from 36 basis points to 16 basis points.
The government is scheduled to undertake gross dates G-Sec borrowing of Rs.7.86 lakh crore during the second half of FY27, while the gap between the budgeted and projected gross borrowing is estimated at around Rs.1.1 lakh crore, the report stated as cited by IANS.
However, the Union Bank noted that net borrowing is expected to remain broadly stable as redemption requirements have been reduced through aggressive bond-switch operations. Such switches defer repayments and consequently, lower refinancing requirements during FY27.
The lender also expects higher Treasury bill issuance and a moderate increase in state government borrowing in order to contribute to additional bond supply.
Meanwhile, the RBI continues to absorb surplus liquidity in the banking system through measures including variable rate reverse repo (VRRR) auctions, OMO sales and foreign exchange swaps.
The RBI conducted three OMO sales in September, cumulatively amounting to Rs.1 lakh crore, which helped in bringing down the banking system's liquidity surplus to Rs.4.85 lakh crore as of September 30 from Rs.11.16 lakh crore on September 6.
The lender expects the RBI to favour rate-based tightening over a broad based cash reserve ration(CRR) increase. It stated that a broad CRR hike appears less likely, particularly after the central bank's earlier decision to exempt eligible FNCR(B) deposits from reserve requirements.
The Union Bank expects a 25 basis point rate increase in October, followed by one or two additional hikes during the rest of FY27. The repo rate could consequently reach 5.75-6 percent accompanied by a hawkish policy stance signalling continued vigilance over inflation.
The report cautioned that the 10 year G-Sec yield could face further upward pressure if monetary tightening coincides with persistently high crude oil prices, rising global yields and weak demand at government bond auctions.
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