Gaura Sen Gupta and Dhiraj Nim both expect the Reserve Bank of India to raise interest rates by 25 basis points this week, but disagree on the message that should accompany the move. Sen Gupta wants a neutral stance that preserves flexibility; Nim favours a tightening bias that signals the direction of rates without committing the central bank to a predetermined path. 

Their exchange reveals why agreement on the next rate decision does not settle the larger argument over monetary policy.

In this economist-to-economist conversation for BasisPoint Insight, Sen Gupta, Chief Economist at IDFC FIRST Bank, and Nim, Economist and FX Strategist at ANZ, take turns as interviewer and interviewee. Each questions the other’s forecasts, challenges the assumptions behind them and asks what would change the policy prescription.

Would Nim still favour an October hike if crude fell to $70 a barrel? Sengupta’s question draws out the distinction between the domestic case for normalisation and the external pressures that have made action more urgent. Nim, in turn, puts the liquidity challenge to Sengupta: how should the RBI prepare to raise rates when banks still hold roughly ₹5 trillion of surplus liquidity? She cautions against permanent withdrawal that could leave the system unnecessarily tight later in the financial year; he does not rule out an incremental cash reserve ratio with an explicit sunset clause.

The discussion tests the charge that the RBI is behind the curve rather than taking it as a starting assumption. From the persistence of inflation to the limits of monetary policy independence, the two examine how far India can follow its domestic priorities when global capital is becoming more expensive, and what the resulting choices mean for the rupee and a bond market facing heavy supply.

The conversation has been edited for length and clarity, and arranged by theme.

Rate Timing

Gaura Sen Gupta: With expectations of a 25-basis-point hike in October, do you think the RBI is behind the curve and should raise rates by 50 basis points, or is this the right time to start normalising?

Dhiraj Nim: We expect a 25-basis-point hike. Whether the RBI is behind the curve depends on how you look at it. Global monetary tightening has begun, and central banks are increasingly treating the supply shock as a risk to inflation expectations. Given the months of balance-of-payments pressure on the currency, one could argue that the RBI is slightly behind.

But the RBI is an inflation-targeting central bank and distinguishes between policies targeting inflation and those targeting the exchange rate. Inflation in India is rising from subdued levels and is only now entering problematic territory. From that perspective, the argument that it is behind the curve is less tenable.

This is the right time to begin, and 25 basis points is the right move. Why do you think some expect 50?

Gaura Sen Gupta: Global factors are being superimposed on India. Developed-market central banks have started hiking, but their domestic circumstances differ. The US has a genuine AI-led investment cycle, with demand contributing to inflation.

India’s inflation was below target and has only recently begun rising. Much of the pressure is supply-led, while the government and oil marketing companies have absorbed a large part of the fuel shock. We expect a gradual normalisation, rather than a catch-up exercise.

Suppose there were a tenable peace agreement in West Asia, and crude fell to $70 a barrel. Would you still be asking for an October hike?

Dhiraj Nim: I would still favour normalisation. At least as of the latest GDP print, growth is somewhat above potential, and there are signs of an investment upturn. Alongside tightening credit-deposit ratios and rising inflation, that would warrant a recalibration. Even our earlier inflation forecasts implied very low real rates.

But the Fed’s move and persistent currency pressure, even after FCNR(B), brought our expected hike forward from December to October. With oil at $70, the choice between those meetings would have been less clear. October also makes sense because it reduces the risk of a perception that we are falling behind, when the next opportunity is December.

Inflation Risks

Gaura Sen Gupta: How do you assess inflation? How much is supply-led or demand-led, and how much is transient rather than sticky?

Dhiraj Nim: Price pressures have been generalising. Sequential momentum in super core inflation has returned to around its historical median. Annualised super core inflation is already around 4.2%, broadly aligned with the target.

That level is not itself a problem, but higher food and fuel prices could persist. The deficient, uneven monsoon, global commodity prices and agricultural input costs could feed through supply chains with a lag. Oil remaining around $90–100/barrel for several months would add pressure even without an outright retail fuel price increase.

We are not expecting inflation to remain persistently above 6%. The concern is persistence rather than a runaway increase. Prices of cereals, pulses, prepared foods and beverages are picking up, and shocks in these categories tend to linger and influence household inflation expectations.

Inflation is rising in a relatively non-disruptive manner, which is the saving grace. But a hike is needed for credibility and to demonstrate preparedness for an extended supply-side shock.

Do you share that assessment, and what risks do you see over the next three to six months?

Gaura Sen Gupta: We have a slightly more constructive assessment. Most inflation still comes from food and fuel, while monetary policy works through demand compression. We are not seeing a substantial demand-side pickup.

There are nevertheless signs of pressure broadening. In core-core inflation, excluding food, fuel and precious metals, around 8% of items by weight are recording inflation above 6%, compared with around 1% a couple of months ago. Commodity pressures are appearing in household products and electronic goods.

Listed manufacturers’ raw material costs rose 27% in the first quarter, but profit growth accelerated despite those pressures. Some costs have been passed on, and consumers have absorbed them, supported by strong urban wage and salary growth.

Our models put average headline inflation at around 5.7% over the four quarters from the second half of 2026–27 to the first half of 2027–28. Against a 5.25% repo rate, that implies negative real rates. We therefore need normalisation, but not restrictive policy, because a large part of these inflation risks can only be handled by the government.

We are still tracking a current account deficit of around 1.7% of GDP for the year, even with crude close to $100 a barrel. That also suggests the economy is not growing above its potential. It is growing, but there is capacity.

Were you surprised by first-quarter GDP and the breadth of growth? What are the downside risks?

Dhiraj Nim: The economy has proved more resilient than expected, benefiting from supply-side changes over the past decade. The surprise was not just the number but the balance between domestic and external demand.

There is also evidence of a private investment upturn. It may be concentrated in a few sectors rather than broad-based, but it lends durability to growth. I expect growth to moderate, though not to worryingly low levels. I am less concerned about growth in this cycle than about inflation becoming entrenched.

Liquidity Choices

Dhiraj Nim: Beyond the rate decision, what do you think of liquidity? Banking system liquidity is still around ₹5 trillion, above a comfortable level for a central bank preparing to hike.

Gaura Sen Gupta: Liquidity is the main challenge because the rate hike must be effective at the weighted average call rate, the operational rate.

Under FCNR(B), banks brought in dollars, which the RBI absorbed through its swap window in exchange for rupees. That injected liquidity. Core liquidity, which includes system liquidity and the government’s cash surplus, rose from around ₹5.1 trillion in March 2026 to a peak of ₹14.2 trillion. FCNR(B) accounted for much of that increase, alongside the RBI’s dividend.

The RBI has already conducted ₹1 trillion of open market bond sales, and its foreign exchange operations have also absorbed liquidity. Core liquidity has fallen below ₹10 trillion.

But this is a transient buildup. Currency leakage was around ₹1.5 trillion in the first six months of 2026–27, against ₹0.8 trillion a year earlier. We estimate almost ₹5.5 trillion of cash withdrawals for the full year. The FCNR(B) window has closed, and we expect a negative balance of payments against the adverse global backdrop.

Even under a benign scenario, core liquidity could fall below ₹4 trillion by March without further RBI action. The challenge is making an October hike effective without withdrawing too much liquidity permanently.

We expect continued use of shorter-tenor swaps maturing within the financial year and VRRRs. We would not recommend another open market bond sale or a CRR hike. Excessive permanent withdrawal now could leave liquidity unnecessarily tight in the fourth quarter. What is your assessment?

Dhiraj Nim: If the RBI hikes on October 7, effective banking liquidity, rather than core liquidity, would need to be around ₹2 trillion–₹2.5 trillion at most for the hike to be effective. I think the RBI can achieve that. Currency intervention also provides an avenue for draining domestic liquidity.

I am not ruling out an incremental CRR, although that differs from your view. It would sit uneasily with the promise made to banks during FCNR(B), but an explicit sunset clause would prevent it from affecting liquidity later in the financial year, when conditions may normalise on their own.

The RBI has been asking banks to place surplus liquidity through the VRRR window for weeks. The probability of a stricter measure is not zero, although the liquidity challenge has become less worrying than we thought a few weeks ago.

Policy Signals

Dhiraj Nim: What should happen to the stance? We have seen considerable changes in how it has been expressed over the past few years.

Gaura Sen Gupta: The stance has become a complicated signalling instrument. Since we expect a shallow cycle of around 75 basis points, bringing real rates towards neutral territory, the stance should remain neutral.

Neutral preserves flexibility. A tightening stance risks becoming forward guidance for a much deeper hiking cycle, when none of us knows how deep it needs to be. If oil falls sharply, commodity pressures, global yields and pressure on the rupee could all ease. For policy normalisation, a neutral stance is sufficient. What is your view?

Dhiraj Nim: I favour a tightening stance, but its meaning needs to be clear. It should indicate that the nominal policy rate has an upward bias, not that real rates must be taken into restrictive territory.

We do not know the real neutral rate with sufficient confidence. Global neutral rates may have risen, while there is also uncertainty about India’s potential growth. Defining the stance through a precise real-rate framework would therefore be difficult.

The RBI could simply explain that a tightening stance means the nominal policy rate can rise from here, while remaining data-dependent at subsequent meetings. Oil prices could fall, but our view is that, even if conditions calm down, they could remain in the $80–90 range for several quarters rather than return quickly to $60–70. The balance of risks still appears tilted upwards.

Gaura Sen Gupta: Even if the RBI defines tightening as allowing pauses and hikes, the market will interpret it as a deeper cycle. It is already pricing around 100 basis points or more. You do not want those expectations to run further ahead when the bond market faces a challenging demand-supply balance.

Global Constraints

Gaura Sen Gupta: How independent is the RBI from the Fed? If the US investment cycle and fiscal pressures keep yields high, and the Fed has to hike more aggressively, does India have a choice or will it be forced to follow?

Dhiraj Nim: The rise in US yields is not just about fiscal risk. It also reflects a reassessment of the neutral rate. Investment in AI, defence and reshoring has strengthened demand for capital relative to savings.

When rates rise in both the US and Japan, competition for global capital becomes stiffer. Capital becomes scarcer and more expensive. No amount of reserves provides immunity indefinitely if those conditions persist.

For a capital- and commodity-importing economy such as India, monetary policy independence becomes constrained. It is difficult to move domestic financial conditions in the opposite direction from a sustained global tightening.

Domestic growth and inflation warrant a shallow hiking cycle. A balance-of-payments perspective would argue for matching the Fed or doing more to limit currency pressure. The RBI will probably deliver something between those considerations.

The market is pricing 100–125 basis points. Although our expected cycle is shallower, I would not argue too strongly against that final hike expectation, given uncertainty about food prices, the pass-through of input costs and inflation risks in 2027.

Gaura Sen Gupta: What should the RBI’s approach to the rupee be? FCNR(B) brings borrowed dollars, which limits how much can be used to defend the currency. But excessive depreciation reduces dollar returns and can encourage further foreign portfolio outflows. How should the RBI manage that trade-off?

Dhiraj Nim: The answer lies between defending a particular level and allowing uncontrolled depreciation. Intervention currently helps with the liquidity problem, but the external challenges have not disappeared.

These dollars are expensive, given the hedging and sterilisation costs. We should be cautious about spending them. At the same time, a runaway depreciation may not be self-limiting. We previously thought a sufficiently weak rupee would attract foreign investors by making assets cheaper, but that did not really happen.

Holding a particular exchange-rate level can exhaust reserves without changing expectations. A prudent approach is to allow gradual depreciation while making clear that the RBI controls the pace and accepts adjustment to changed external conditions.

You can fight market sentiment, but not global economics. At present, market sentiment is following those changes in global economics.

Market Implications

Dhiraj Nim: How do you assess the yield curve in light of monetary policy expectations and global bond-market spillovers? Where are the risks?

Gaura Sen Gupta: The supply challenge is substantial. Central government issuance is slightly below ₹16 trillion in 2026–27, while we estimate state government supply at around ₹14 trillion–₹14.5 trillion.

The Centre’s borrowing is now distributed almost equally between the two halves of the year following the West Asia disruption. States generally borrow around 60% in the second half. That means a significant supply buildup, with the Centre and states competing for resources.

There is also fiscal slippage risk from fertiliser subsidies and the excise cuts used to absorb part of the oil shock. We estimate that at around 0.2% of GDP. But we do not expect additional market borrowing on that account, because the Centre and states have substantial cash surpluses they can draw down.

At the same time, the RBI must drain liquidity and has added bond supply through open market sales. The market is also anticipating around 100 basis points or more of rate increases. There is pressure across the curve.

The short end faces liquidity withdrawal and rate hikes. The long end faces substantial duration supply, particularly from states. Around 65% of state government borrowing in the first half was at maturities of 11 years and above. The Centre has also shifted some second-half supply towards the ultra-long end.

Rate hikes may reduce the curve’s steepness, but it should remain relatively steep because of supply at longer maturities. Global yield curves are also steep, and India cannot escape that pressure.

Corporate bond issuance has picked up as well. The RBI’s use of sell-buy swaps has pushed forward premia higher, raising the cost of hedged dollar borrowing relative to domestic borrowing. That is encouraging domestic issuance and could weaken debt capital inflows if forward premia remain elevated.

The choice of liquidity instrument therefore matters. The more heavily the RBI relies on one instrument, the more that market becomes distorted. Liquidity normalisation needs to be spread out or undertaken more gradually while the rate-hiking cycle is implemented.