India’s Reserve Bank (RBI) is facing pressure to adopt a more hawkish monetary policy amid a record surge in foreign capital inflows and rising inflationary pressures. In recent months, the RBI successfully attracted approximately US$133 billion from the Indian diaspora, a flow that has significantly increased liquidity in the banking system and pushed overnight borrowing rates below the central bank’s current policy rate of 5.25%.

This unprecedented influx of funds has left banks with excess cash and contributed to robust credit growth and resilient domestic demand. At the same time, inflation has been on the rise, fueled in part by higher food prices and sustained elevated oil costs, which further complicates the RBI’s monetary policy outlook.

To combat these inflationary risks and prevent excessive liquidity from stoking price pressures, the RBI has intervened by draining over one trillion rupees (roughly US$10.4 billion) through bond sales and other liquidity-absorbing measures. Market analysts anticipate the central bank will continue such efforts in the near term.

Adding to expectations, several economists and financial institutions now foresee the RBI initiating an interest rate increase at its policy meeting next week—the first hike since early 2023. Prominent among these voices is Sajjid Chinoy, chief India economist at JP Morgan Chase & Co, who emphasized the importance of the RBI adopting a “cautious or hawkish tone” in its communications to signal potential further tightening. Economists at Nomura Holdings Inc., Deutsche Bank AG, and Australia and New Zealand Banking Group have similarly revised their forecasts, anticipating policy tightening sooner than previously expected.

Market pricing reflects this shift, with traders now factoring in as many as four rate increases over the next year, up from three expected at the end of June, according to Abhishek Upadhyay, economist at ICICI Securities Primary Dealership. This comes against the backdrop of September’s record surplus banking liquidity, which peaked around 11 trillion rupees (approximately US$115 billion), largely driven by commercial banks exchanging dollars for rupees through RBI mechanisms.

The surge in liquidity has also helped the RBI’s foreign exchange reserves approach nearly US$800 billion, making India the world’s fourth-largest reserve holder. However, economists warn that failing to address the excess cash could undermine monetary policy transmission, damage the RBI’s credibility, and distort asset market pricing. Analysts from Citigroup advocate for continued use of short-term foreign exchange swaps and potential additional bond sales, estimating up to one trillion rupees in bond sales as a viable option.

Despite these interventions, the rupee has depreciated by over 6% this year, remaining among Asia’s worst-performing currencies. The currency currently trades near the levels seen before the RBI introduced its Foreign Currency Non-Resident (FCNR) deposit scheme. In response, the central bank has actively sold dollars to support the rupee, which was quoted at 95.8987 per dollar most recently.

Rising global oil benchmarks, including Brent crude’s third consecutive monthly increase in September, have further aggravated inflationary pressures, complicating the RBI’s balancing act between growth and price stability. Deutsche Bank’s Kaushik Das noted that the RBI might consider raising the cash reserve ratio as a last resort should other liquidity management tools prove insufficient.