Hawkish RBI raises rate 50 bps to fight inflation

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RBI expects inflation to be at around 6% by March 2012, with an “upward bias" and that it will continue to stay at the current level till September. Wholesale price inflation was 8.98% in March, higher than RBI’s twice-revised year-end projection of 8%.

The central bank pegged India’s economic growth projection for fiscal year 2012 at “around 8%", a full percentage point lower than what finance minister Pranab Mukherjee had projected in his February budget speech.

It also raised the savings deposit rate by an identical margin to 4% ahead of freeing the rate, the last bastion of a mandated rate regime, and moved to a single policy regime.

The rate hike and other measures such as higher provisioning requirements for bad loans will push up the cost of funds for banks and they are bracing for a rise in their loan as well as deposit rates.

IDBI Bank Ltd became the first bank to hike its loan rates by 50 basis points (bps) on Tuesday evening to take its minimum lending rate, or base rate, to 10%, effective 5 May. It also hiked its deposit rates by 25-50 bps across various maturities.

One basis point is one-hundredth of a percentage point.

Mortgages and auto loans could rise by 50-100 bps, said Chanda Kochhar, managing director of India’s largest private sector lender ICICI Bank Ltd.

The bond market did not react sharply to the policy and the yield on 10-year benchmark government paper rose by 5 bps, but the equity market bore the brunt and the Bombay Stock Exchange’s bellwether equity index, Sensex, lost 2.44% to close at 18,534.69 points.

Rate-sensitive stocks were hurt the most. The Bankex index of banking stocks lost 3.11%, while the auto index fell 3.74%—the sharpest fall among all sectoral indices—and the realty index lost 2.91%.

In a rising interest rate regime, consumer demand for automobiles and homes goes down as loans become costlier and banks take a hit on their bond portfolio as they need to make good the depreciation in the value of bonds.

Shares of State Bank of India, (SBI) the nation’s largest lender, lost 4.03% to close at ₹ 2,583.10 apiece and those of Punjab National Bank dropped 4.7% to end at ₹ 1,096.85. Among other big losers, ICICI Bank’s shares fell 2.76%, HDFC Bank Ltd’s 2.4% and Axis Bank Ltd’s 3.54%.

In the auto pack, shares of Tata Motors Ltd lost 5.3% to close at ₹ 1,163.45 apiece, those of Mahindra and Mahindra Ltd, 4.47% to end at ₹ 707.85 and Bajaj Auto Ltd’s, 5.02% to close at ₹ 1,366.95.

With this policy, RBI has also ushered in a single policy rate regime in India. Till now, RBI has been operating through repo and reverse repo rates—one for injecting liquidity and the other for draining it out. This means, in a cash-surplus situation, which had been the case in 2009, reverse repo was the policy rate. Currently, repo is the policy rate.

From now on, repo will be the effective policy rate and the reverse repo rate will be benchmarked to it and always be 100 bps lower.

RBI also introduced a marginal standing facility (MSF) through which banks can borrow overnight money up to 1% of their deposit base. MSF will always be 100 bps above the repo rate.

Following this, the corridor through which liquidity is managed by RBI has widened to 200 bps from 100 bps, the difference between the repo and reverse repo rates. “This facility is expected to contain volatility in the overnight inter-bank market," the central bank said.

Since March 2010, RBI has taken eight “baby steps" to raise policy rates and fight inflation, but that does not seem to be enough.

“Current elevated rates of inflation pose significant risks to future growth. Bringing them down, therefore, even at the cost of some growth in the short run, should take precedence," governor D. Subbarao said in his annual policy speech, leaving no room to speculate that RBI has for now departed from balancing growth and inflation. A day before the policy announcement, the central bank’s macroeconomic review, too, said that the time is ripe to take some quick and decisive action against inflation.

“There is no trade-off between growth and inflation. We need to bring down the inflation," Subbarao said during a post-policy press conference.

Industry bodies reacted sharply to RBI’s rate hike.

“This is certainly a very hawkish monetary stand and one which would make the investment environment even more difficult. We are afraid that with growth slowing, as now admitted by RBI, employment targets will not be achieved and this could generate greater social pressure," said Rajiv Kumar, director general of industry lobby Federation of Indian Chambers of Commerce and Industry.

Analysts do not see the end of the rate hike cycle as yet.

“...inflation will not be influenced meaningfully by this rate increase alone," said Siddhartha Sanyal, economist for India at Barclays Capital. “We factor in a cumulative 50 bps hike in the next two policy announcements," Sanyal wrote in a report released after the policy.

“We now expect another 50 to 75 bps of rate hikes in policy rates and then an extended pause," said Robert Prior-Wandesforde, head of India and South-East Asia economics research at Credit Suisse AG.

On its part, RBI did not offer any guidance, but said it would “continue" with its “anti-inflationary stance", signalling more rate hikes in coming months if inflation does not come down.

In another significant move on Tuesday, RBI increased the savings deposit rates by 50 bps to 4%, the first such hike after 19 years. The hike in the savings bank rate is a pre-cursor to deregulating the rate completely, the central bank said.

RBI recently released a discussion paper on the deregulation of the savings bank rate and this could be freed after taking feedback from the general public. Savings accounts account for around 22% of the total deposit base of about ₹ 53.2 trillion. Depending on the savings account portfolio of different banks, margins could be squeezed by 12-15 bps for banks, Union Bank of India chairman and managing director M.V. Nair said at a post-policy meeting with the media.

According to SBI chairman Pratip Chaudhuri, a hike in the savings bank rate will actually increase banks’ savings account portfolio as customers will be encouraged to keep more funds with banks.

Still, a hike in savings bank rate and increased provisioning for bad loans will push the cost of funds for banks, but they may not be able to pass on the entire cost to the customers and part of it may have to be absorbed by the lenders, given the competitive and fragmented banking scenario, admitted Chaudhuri.

Graphic by Sandeep Bhatnagar/Mint

Joel Rebello contributed to this story.

anup.r@livemint.com

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