Repo rate up, stocks down: Should equity investors worry? History offers hope

On October 7, the Reserve Bank of India (RBI) raised the repo rate by 25 bps from 5.25 per cent to 5.50 per cent—the first hike since February 2023. The RBI changed its stance to “calibrated tightening”.

The repo rate, short for repurchase rate, is the rate at which the RBI lends short-term funds to banks against eligible securities, with an agreement to repurchase those securities at a later date. The repo rate is used as a tool to control inflation.

A repo-rate hike is normally negative for equities in the short term, but the historical Indian experience shows that a rate hike does not automatically lead to a prolonged stock-market fall. The reason for the hike, expected future rate path, economic growth and earnings matter more than the 25-bps hike itself.

On the day of the announcement, that is on October 7, the Sensex fell by 0.59 per cent and Nifty 50 by 0.76 per cent. On the next day, the Sensex further fell by another 1.44 per cent and the Nifty 50 has by another 1.64 per cent.

Also read: As RBI tightens screws, what it means for your loan, home and food bill

Why does a repo hike hurt equities?

Higher borrowing costs: Companies with substantial debt face higher interest expenses reducing profits.

Lower valuation multiplies: Higher interest rates increase the discount rate used to value future earnings. Therefore, the theoretical fair value of stocks, particularly high PE growth stocks can decline.

Consumption gets affected: Higher EMIs can reduce discretionary spending, affecting automobiles, housing, consumer durables, and other interest-sensitive sectors.

Fixed deposits and bonds relatively more attractive: Higher yields on deposits and bonds can make fixed-income investments relatively more attractive, particularly for risk-averse investors.

Conventionally it is depicted as follows:

Inflation ↑ → rates ↑ → borrowing costs ↑ → earnings pressure → equities ↓

Also read: Stock markets decline in early trade as RBI signals more tightening

What does history tell us?

This is the more interesting part. Here are four separate cases:

2004–08: Rates rose sharply, but Nifty soared

During 2004–08, RBI increased the repo rate from 6 per cent to 9 per cent — a 300-bps increase.

Yet the Nifty rose approximately 114 per cent during the period.

Why? India was experiencing very strong economic growth, with corporate earnings and investment rising strongly. Thus, earnings growth overwhelmed the negative valuation effect of higher interest rates.

2010–11: The classic negative example

RBI raised the repo rate from 5 per cent to 8.5 per cent—350 bps—between March 2010 and October 2011.

The Nifty was approximately flat during the rate-hike period and subsequently suffered a significant correction as inflation and macroeconomic pressures intensified.

This is much closer to the conventional textbook relationship.

Also read: How RBI rate hike impacts your EMIs, FDs, investments: Sahaj Money founder explains

2018: Two hikes, but Nifty still gained

In 2018, RBI increased rates twice. Despite the tightening, the Nifty gained roughly 3.4 per cent during the period.

Again, the market reaction was not simply determined by the rate increase itself.

2022–23: 250-bps increase, but equities eventually recovered strongly

This is probably the most useful recent comparison.

The 2022–23 cycle provides another useful example. RBI raised the repo rate from 4 per cent to 6.5 per cent, a 250-bps increase. Depending on the measurement period used, analyses show very different equity-market returns during this cycle. One analysis calculated a gain of about 41 per cent from the beginning of the hiking cycle to the subsequent rate-cut phase. This illustrates why the chosen measurement window matters.

So what is the lesson?

A rising repo rate and a rising stock market can coexist. The RBI itself has an important observation.

An RBI research paper analysing monetary-policy transmission found that the surprise in the current repo-rate decision had relatively little effect on equity returns, whereas the market’s expectations about the future path of monetary policy were much more important. This explains why the October 2026 hike needs to be viewed differently from a simple “25 bps = bearish” calculation.

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The market already expected a 25-bps hike. Therefore, the hike itself was largely priced in.

What potentially matters more is the phrase: “Calibrated tightening”. That signals that RBI is no longer merely holding rates steady; further tightening remains possible depending on inflation and growth. That is potentially more important for equities than the present 25-bps increase.

GDP growth

The current situation has an unusual combination: RBI raised its repo rate while maintaining a 7.1 per cent FY27 GDP growth forecast. That means the central bank does not currently see the economy as too weak to withstand tighter monetary policy.

Takeaway

We need not interpret the two-day fall of Sensex/Nifty 50 as evidence that a major equity bear market has begun. We also do not know how much of a fall is on account of repo rate hike and how much is on account of increased crude prices in the international market coupled with a strong dollar index. We must also keep in mind that already the market was factoring in the increase of 25 basis point repo rate.

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A repo-rate hike is generally a short-term headwind for equities, but the historical evidence does not support a mechanical relationship between rate hikes and stock-market declines. What matters is why rates are being raised, how much of the move is already priced in, what RBI signals about future rates, and whether economic growth and corporate earnings remain strong.

The more important indicators over the next few months will be:

• Whether RBI hikes repo rate again
• Inflation, particularly oil-driven inflation
• 10-year G-sec yield
• Corporate earnings growth
• FII flows
• Credit growth
• Nifty forward P/E
• Whether the rupee stabilises.

Meanwhile, equity investors must strictly adhere to their asset allocation plan based on their risk appetite.