11.7 Monetary transmission: RBI and Fed
Motivation
A repo hike does nothing directly to a stock price. It changes overnight money-market rates. Those move T-bill and bond yields, which move lending rates, deposit rates and the rupee, and these in turn move earnings and the discount rate. Knowing the plumbing tells you which asset reacts first and by how much.
11.7.1The RBI's operating framework (as of 6 Nov 2026)#
| Instrument | Level | Role |
|---|---|---|
| Policy repo rate | 5.50% | The rate at which the RBI lends to banks against government securities. The MPC sets it. |
| Standing Deposit Facility (SDF) | 5.25% | Floor of the corridor. Banks park surplus cash with the RBI without collateral. |
| Marginal Standing Facility (MSF) | 5.75% | Ceiling. Emergency overnight borrowing against G-secs, including those held under SLR. |
| Bank Rate | 5.75% | Aligned with the MSF. Used for penal rates. |
| Cash Reserve Ratio (CRR) | 3.00% | Share of deposits banks must hold with the RBI, unremunerated. |
| Statutory Liquidity Ratio (SLR) | 18% | Share of deposits held in liquid approved securities, mainly G-secs. |
Source: RBI homepage, read 6 Nov 2026 [V]. The repo was raised by 25 bp, from 5.25% to 5.50%, on 7 Oct 2026 by unanimous vote (SDF 5.25%, MSF and Bank Rate 5.75%), and the stance moved from "neutral" to "calibrated tightening", with two members (Dr. Nagesh Kumar and Prof. Ram Singh) preferring to keep it neutral1. The next MPC meeting is 2–4 Dec 2026.
Mechanics:
- The LAF corridor. LAF is the Liquidity Adjustment Facility, the RBI's set of overnight and term operations. Its corridor runs from SDF (repo − 25 bp) to MSF (repo + 25 bp). The operating target is the weighted average call rate (WACR), the overnight interbank rate. Arbitrage keeps the WACR inside the corridor. It sits near the SDF when system liquidity is in surplus and near the MSF when it is in deficit. A trader reads "liquidity" on the RBI's daily money-market release: net LAF absorption means surplus.
- Liquidity tools. These are variable-rate repo (VRR) auctions to inject cash, variable-rate reverse repo (VRRR) auctions to absorb it, open-market operations (OMOs, outright purchases or sales of G-secs), FX swaps, and the CRR. A 25 bp cut in CRR releases roughly 0.25% of the deposit base as reserves. A CRR change is therefore a quantity tool that acts like a rate cut at the short end without changing the repo.
- FX intervention and sterilisation. When the RBI sells dollars to defend the rupee, it absorbs rupees, which drains domestic liquidity and pushes the WACR up. To offset this it can inject rupees through VRR or OMO purchases. This is sterilisation. In 2026 the RBI ran a special dollar window for oil marketing companies and an FCNR(B) deposit scheme to attract dollars2. Both are 2013 playbook tools (11.16).
- Transmission to loans. Repo-linked (external-benchmark) floating loans reprice within a quarter. MCLR-linked loans reprice with a lag. MCLR is the marginal-cost-of-funds lending rate, an internal bank benchmark. Deposit rates lag further. Equity analysts therefore expect bank net interest margins to widen briefly after hikes and compress after cuts.
11.7.2The Fed and global spillovers#
The FOMC (Federal Open Market Committee) meets eight times a year. It sets a 25 bp target range for the fed funds rate and enforces it mainly by setting the interest on reserve balances (IORB) and the overnight reverse repo rate (ON RRP). Its balance sheet (quantitative easing and tightening) works on term premia (11.5.2).
The 2026 path: the Fed cut to 3.50–3.75% in Dec 2025, then raised 25 bp to 3.75–4.00% on 16 Sep 2026, its first hike since July 2023. It held on 28 Oct 2026 by a 10–2 vote; Cook and Hammack dissented in favour of a hike. Kevin Warsh is Chair3.
Why the Fed is everyone's central bank Four channels carry a Fed tightening to India:
- Rate differential. Higher US yields lower the carry on Indian bonds for foreign holders, so foreign portfolio investors (FPIs) sell Indian debt and the rupee weakens.
- The dollar. A stronger dollar tightens financial conditions for anyone who borrowed in dollars (11.10).
- Risk appetite. A higher US discount rate lowers global equity valuations, and EM equities, being higher-beta, fall more.
- Global financial cycle. Capital flows, leverage and credit growth co-move across countries, driven by US monetary policy and the VIX. A central bank with an open capital account can keep monetary independence only by letting the exchange rate absorb the shock. This is Hélène Rey's "dilemma, not trilemma" argument (Rey 2013, Federal Reserve Bank of Kansas City Jackson Hole symposium).
The impossible trinity A country cannot simultaneously have (a) a fixed exchange rate, (b) free capital mobility and (c) independent monetary policy. Proof sketch: with (a) and (b), uncovered parity (11.9) forces , so (c) is lost. India runs a managed float with partial capital controls. The RBI smooths volatility with reserves rather than defending a level. The rupee depreciated about 10% in 2022 (USDINR 74.32 → 82.72, a rise of 11.3%4) because the RBI chose not to defend a level.