Daijiworld Media Network - New Delhi

New Delhi, Sep 4: The Reserve Bank of India (RBI) could raise its key repo rate to 5.75-6 per cent in the second half of FY27 as it seeks to contain excess banking liquidity and rising inflation amid strong economic growth, according to a Union Bank of India report.

The report expects two to three rate hikes of 25 basis points each from the current repo rate of 5.25 per cent, with the rate-hike cycle likely to begin in December under its base-case scenario.

“Rate hikes are back on the table for H2 FY27,” the report said, adding that December appeared to be the more likely starting point.

The outlook comes amid a sharp rise in foreign exchange inflows under the RBI’s special swap facility, which reached around $136 billion as of August 31.

Of this, $127.23 billion came through Foreign Currency Non-Resident (Bank) [FCNR(B)] deposits, while the remaining inflows came through overseas foreign currency borrowings and external commercial borrowings.

The report said these inflows have significantly increased liquidity in the banking system. Core liquidity rose to Rs 8.05 lakh crore by mid-August, compared with Rs 4.82 lakh crore in mid-June.

In an illustrative scenario, core liquidity could rise further to around Rs 14.17 lakh crore by September 11, making liquidity management a key policy challenge for the central bank.

“After getting dollar flows, now rupee liquidity management is key policy challenge for RBI,” the report said.

Union Bank of India expects the RBI to announce measures to absorb excess liquidity before its October policy meeting.

Among the measures considered highly likely are short- and longer-term variable rate reverse repo operations (VRRR) and an incremental cash reserve ratio (I-CRR).

The central bank could also consider bond sales and foreign exchange swaps to absorb surplus liquidity, the report said.

The PSU bank expects the RBI to initially rely on temporary measures that can be reversed as credit demand strengthens in the second half of FY27.

It also estimates that a 50:50 mix of short-term VRRR and longer-duration measures could be used to absorb the projected liquidity surplus.

However, a rate hike in October cannot be ruled out if the US Federal Reserve raises interest rates in September and the RBI first absorbs excess liquidity through durable measures, the report said.