The Reserve Bank of India has increased its benchmark repo rate for the first time since 2014 on the back of a surge in crude oil prices, which have raised inflationary concerns. The hike also comes at a time the Rupee has depreciated against the US Dollar, while foreign institutional investors have also been pulling out of India's debt and equity markets on expectations of more rate hikes by the US Federal Reserve.
The RBI had left the repo rate unchanged at 6 per cent since cutting it by 25 basis points (0.25 per cent) last August. On Wednesday, the central bank raised the rate at which it lends to banks by 25 basis points to 6.25 per cent, although it continued to maintain its “neutral” policy stance. Consequently, the reverse repo rate will now be at 6 per cent and the marginal standing facility rate and bank rate at 6.50 per cent.
Abheek Barua, chief economist at HDFC Bank, said it was a “sensible and cautious response” to the risks that have unfolded since the last monetary policy committee (MPC) meeting in April.
“It looks like that RBI, taking note of both the domestic inflation and inflationary build up in combination with US Fed’s stance with respect to unwinding of its balance sheet, decided to go for an increase in the repo rate, rather than waiting for more data and monsoon progress,” said Devendra Pant, chief economist at India Ratings.
India's consumer price inflation (CPI) jumped to 4.58 per cent in April versus 4.28 per cent in March. Crude oil prices rose sharply till May 24 on heightened geopolitical tensions, touching $80 per barrel before easing a little. That has led to a rise in prices of crude-linked commodities, which companies will pass on to consumers.
“Since the MPC meeting in early April, the price of Indian basket of crude has surged from $66 a barrel to $74 a barrel. This, along with the increase in other global commodity prices, has resulted in firming up of input cost pressures and persistence in the higher CPI projections for 2018-19. The price of the Indian crude basket imparts considerable uncertainty to the inflation outlook,” said Urjit Patel, governor, RBI.
The RBI has revised its inflation projections for 2018-19. For the first half of the year, it now expects the consumer price inflation to range between 4.8 per cent to 4.9 per cent, versus 4.7 per cent to 5.1 per cent it had expected earlier. Similarly, in the second half, it now sees retail inflation at 4.7 per cent, versus 4.4 per cent it had projected in the previous MPC meeting.
The Rupee has also depreciated; it closed at 67.15 to the Dollar on Tuesday and has weakened more than 4.5 per cent so far this year. Over April and May, FIIs sold Rs 10,500 crore worth equity and pulled out close to Rs 30,000 crore from the debt market.
On the other hand, India's economic growth has strengthened with the GDP rising 7.7 per cent in the January-March quarter, its fastest pace since demonetisation, and Viral Acharya the deputy governor of RBI said the growth indicators suggested that the economic revival was on a "strong footing."
While the monsoon rain is expected to be normal this year and should boost agricultural activity, the impact of inflation of the minimum support price increases on agricultural produce remains uncertain.
Meanwhile, the Federal Reserve is meeting next week, and could increase interest rates further after a strong jobs data in the US.
Given all the moving parts, there is a broader view that the RBI may hike its repo rate at least one more time this year.
“This is not likely to be end of the hike cycle as domestic price risks such as MSP hikes and firm global commodity prices would warrant further monetary action,” said Barua of HDFC Bank.
The extent of upward pressure on food prices, risks of fiscal slippages, domestic growth recovery and evolving global macro-economic conditions, including the impact of trade wars and commodity prices, would have to be closely watched, said Suvodeep Rakshit, senior economist at Kotak Mahindra Bank.
“We expect the RBI to hike by another 25 bps in the August policy, but the call will hinge on how crude and Rupee movements pan out over the next few months, as well as the extent of MSP hikes,” said Rakshit.
How will the rate hike impact borrowers?
Several banks had already hiked interest rates ahead of the the RBI MPC, so all new borrowers would already have to pay a higher EMI (equated monthly installment) on home loans, personal loans and auto loans, which are linked to the marginal cost of funds-based lending rate.
Last week, the country's largest lender, State Bank of India, raised the lending rate by 10 basis points across tenors up to three years. So, its MCLR rate for one year tenor effective June 1 stands at 8.25 per cent, versus 8.15 per cent earlier, while that for two year and three year tenor stands revised at 8.35 per cent and 8.45 per cent respectively.
Other leading banks like state-owned Punjab National Bank and ICICI Bank, the country's largest private sector lender, also followed suit and raised their MCLR-based lending rates.
“An existing borrower may not immediately witness any change in their EMI amount, but a higher interest rate would eventually increase the long-term interest out-go,” said Adil Shetty, CEO of BankBazaar.com.
It won't be a surprise if your interest rates on loans go up now. With the RBI increasing the repo rate, other banks may also raise their interest rates.
Rising interest costs now could also have an impact on the overall investment cycle, point out experts.
“Domestic bond yields have recorded a considerable hardening in the recent months, in line with global trends as well as a decline in the systemic liquidity surplus, and emergence of fiscal and inflationary risks. Moreover, back-ended monetary tightening in 2018 may push up bank lending rates. Accordingly, interest costs are likely to rise in the current fiscal, which would weigh upon margins as well as the strength of the investment recovery in FY2019,” said Naresh Takkar, MD and group CEO of ICRA.