There was little suspense over whether the Reserve Bank of India would raise rates this week. Now the question is what comes next, and how far the RBI might ultimately have to go.

The MPC delivered the widely expected 25-basis-point hike, taking the repo rate to 5.50%. But it was the shift in stance to “calibrated tightening” that carried the stronger signal. The message is unambiguous: this is the beginning of a rate-hiking cycle, not a one-off insurance hike.

The decision reflects a changing balance between growth and inflation. The RBI raised its 2026-27 inflation forecast by 20 basis points to 5.2% and, importantly, flagged early signs of price pressures becoming more generalised. At the same time, it revised its growth forecast sharply higher, from 6.7% to 7.1%. The combination is important. Resilient growth gives the central bank greater room to focus on emerging inflation risks.

The inflation trajectory is likely to worsen before it improves. Inflation could average around 5.4% in 2026-27 and remain above 6% over the next two quarters. The September print itself could rise to around 5.9%, from 4.8% previously.

The composition of inflation will matter as much as the headline number. As growth holds up, some of the increase in input costs is likely to be passed on to consumers. Core inflation could consequently rise from an average of 4.1% in the first half of 2026-27 to around 4.7% in the second. Signs of such second-round effects would understandably keep the RBI cautious.

This makes further rate hikes necessary. It does not, however, automatically make the case for a much larger hiking cycle. Another 50-75 basis points of tightening is likely over the next few meetings, with consecutive hikes more likely than a staggered approach. This would take the repo rate to 6-6.25%. The question is whether the RBI would need to go materially beyond this.

Much will depend on four factors. A prolonged West Asia conflict that keeps crude prices elevated would make India’s inflation problem both larger and more persistent. Equally important will be the extent of the pass-through from higher input costs to retail prices, the evolution of El Nino and its impact on the winter crop, and the resilience of domestic demand as financial conditions tighten.

While each of these presents an upside risk to rates, a significantly longer and more aggressive hiking cycle is not yet the most likely outcome.

In the base case, assuming these risks do not intensify materially, inflation should begin moderating by the middle of next year, averaging around 4.5% in the second half of 2027-28. With the repo rate reaching 6-6.25%, this would imply a real policy rate of around 1.5-1.75%—within the broad range that previous RBI studies have associated with a neutral real rate.

Alongside rates, liquidity will be the other important part of monetary tightening.

The RBI refrained from announcing any additional liquidity measures this week, preferring instead to continue using sell/buy swaps, VRRRs and, where required, OMO sales to absorb the surplus.  Liquidity has already moderated considerably. Another ₹2-3 trillion may need to be absorbed to bring overnight rates closer to the middle of the policy corridor. Some of this adjustment should occur naturally as festive-season currency demand, tax outflows and continued foreign-exchange intervention drain liquidity. By the final quarter of 2026-27, liquidity conditions could tighten considerably and potentially move into deficit.

For bond markets, a further adjustment could therefore come at the short end of the curve. As policy rates rise and liquidity normalises, short-term yields have further room to move higher, leading to a flatter yield curve. At the longer end, global yields and the inflation trajectory will remain important drivers, with the decision to do any further OMO sales by the RBI triggering a further upside move.

The rupee presents a different story. The current rate-hiking cycle is unlikely, by itself, to provide enough support to the currency. Depreciation pressures are being driven by a broader set of global factors—including elevated oil prices, foreign portfolio outflows, the global AI trade and dollar strength—that higher domestic interest rates cannot offset.

The RBI is therefore likely to continue intervening actively in the foreign-exchange market to stall depreciation pressures and contain excessive volatility. The Governor’s observation that the rupee does not appear overvalued on measures such as the REER is important in this context, particularly when a weaker currency could add to imported inflation. Intervention, however, can smooth the adjustment rather than eliminate the underlying pressure. If the conflict in West Asia does not subside and oil prices remain elevated, some gradual depreciation of the rupee is likely over the coming quarters.

The case for further tightening over the next few meetings is fairly clear. Inflation pressures are rising and resilient growth provides the RBI with the space to respond. However, the path ahead remains conditional. In the base case, as the current inflation shocks fade, a repo rate of 6-6.25% should provide sufficient monetary restraint. A more prolonged cycle would require the balance of risks to shift materially—through persistently high oil prices, stronger second-round inflation effects or renewed food-price pressures. For now, these remain risks rather than the central case.