Mumbai: India’s bellwether equity index plunged to its lowest this year and the yield on benchmark government bonds rose to a near seven-year high as a sense of panic gripped stock and bond traders after the inflation rate surged to a 13-year peak.
The Bombay Stock Exchange’s Sensex index lost 3.4%, or 516.70 points, to 14,571.29 at the close of trading on Friday. The 10-year government bond yield rose to 8.68%.
HDFC Bank Ltd, India’s second-largest private sector lender, raised its prime lending rate, or the rate at which it lends to its best customers, by a quarter percentage point to 15.25%, and other banks may follow suit sooner than later.
Some bankers and bond dealers expect the Reserve Bank of India (RBI) to raise its policy rate and tighen liquidity by raising banks’ cash reserve ratio (CRR), or the money that commercial banks are required to keep with the Indian central bank as a portion of their deposits.
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The RBI is expected to move ahead of the quarterly review of monetary policy due in the last week of July.
But whether the central bank will wait five weeks to raise its policy rate or not, banks are readying themselves to raise their lending and deposit rates.
Since the RBI on 11 June raised the rate by a quarter percentage point to 8%, inflation has risen by close to 3 percentage points.
The inflation rate hit 11.05% in the week ended 11 June, government data showed Friday.
“We expect strong action from RBI to break the back of inflation expectations. Welook for a half-a-percentage point hike in policy rate in the July policy review,” said A. Prasanna, senior economist at ICICI Securities Primary Dealership Ltd, a firm that buys and sells government bonds.
Along with the 30-stock Sensex, the National Stock Exchange’s broader 50-stock Nifty index also closed at the year’s low of 4,347.55 and both the indices are inching towards levels seen in August 2007.
According to brokers and fund managers, some panic selling by traders had taken its toll on the indices but the larger damage was done by a few foreign funds that used the opportunity to short-sell stocks.
Short selling is the practice of selling borrowed securities in the hope of buying them back at a lower price.
“Low trade volume (in the market) is helping the short sellers to drive down prices at will,” said Jignesh Desai, head of institutional sales at SBI Capital Market Ltd.
According to a portfolio fund manager in Mumbai, who did not wish to be named, many institutional investors have been short-selling stocks in the past two days, expecting the double-digit inflation figure.
The Sensex has lost more than 7% in the past three trading sessions after a relief rally that extended to Tuesday.
Both the Sensex and the Nifty are down around 30% from their highs this year. There could be a sharper fall next week, said Nitin A. Khandkar, head of equity research at Mumbai-based Keynote Capitals Ltd.
Most bond dealers say they expect the RBI to tighten the leash by both raising its policy rate and the CRR to rein in inflation. “We expect the RBI to act immediately,” said S.S. Raghavan, head of treasury at IDBI Gilts Ltd, a primary dealer.
He said inflation could touch 12% and the benchmark 10-year bond yield may cross 8.75%.
Mohan Shenoi, head of treasury at Kotak Mahindra Bank Ltd, expects the yield to rise to 9% and the RBI to employ more than one monetary measures soon.
“There is a good chance that the central bank will not wait until the next formal review, which is scheduled for July,” said Sherman Chan, an economist at rating agency Moody’s Investors Service.
Robert Prior-Wandesforde of Indian economics team at the British bank HSBC, however, says the RBI should start more active intervention in the currency market to push up the rupee.
“This would be the more effective and quicker means of controlling inflation,” he said. A stronger rupee brings down the cost of imports.
ICICI Bank Ltd, India’s largest private sector lender, will wait and watch “The fiscal and monetary steps taken by the government and central bank will take somtime to show their effect. We are waiting for cues from RBI,” said V. Vaidyanathan, executive director.
Chennai-based Indian Bank will decide after a fortnight, said Sundara Rajan, chairman and managing director.
Deepak Parekh, head of India’s oldest mortgage lender, Housing Development Finance Corp. Ltd, said earlier the lender will decide on a rate in the first week of July.
O.P. Bhatt, chairman and the managing director of the country’s largest lender State Bank of India, also recently indicated that his bank is in no hurry to revise rates.
With the inflation rate surging, banks may not adopt the wait-and-watch stance for long.