Mumbai: The Reserve Bank of India (RBI) on Thursday raised its key policy rates for the eighth time in a year to fight inflation in the world’s second fastest growing major economy and indicated that more hikes would come even as it increased its year-end projection for inflation to 8% from 7% estimated in its January policy.
The mid-quarter hike of 25 basis points (bps), which has taken the Indian central bank’s repo rate—or the rate at which it infuses liquidity into the system—to 6.75%, and the reverse repo rate—or the rate at which RBI drains liquidity—to 5.75%, was in line with market expectations. That could explain why the yield on the most-traded 11-year bond rose only 1 basis point to 8.08% during the day. The benchmark five-year interest rate swaps rose 7 bps to 7.87% after the policy announcement. One basis point is one-hundredth of a percentage point.
Also See Guarded Steps (PDF)
India’s bellwether equity index, the Sensex, dropped 1.14% to 18,149.87 points on fears that the Indian central bank could resort to more such rate hikes during the year with inflation remaining persistently high, driven by demand as reflected in the rise of non-food manufacturing inflation. Till recently, food inflation was the main concern of the regulator.
While bankers agree that rates are heading north, they have not decided as yet on the timing of the hike in their loan and deposit rates. Most have raised their loan rates at least twice and deposit rates many times since January.
“We are at the last phase of the fiscal year. Credit demand may come down in April and liquidity will be comfortable. I don’t think there will be any rate hike immediately,” said Bank of Baroda chairman and managing director M.D. Mallya.
Renu Sud Karnad, managing director of India’s largest mortgage lender Housing Development Finance Corp. Ltd, which raised its loan rate by 25 bps a fortnight ago, said there would not be any immediate rate hike.
Canara Bank chairman and managing director S. Raman, however, said there is a case for a rate hike. “Most likely we have to transfer it (the hike) to the customer. Cost of funds have gone up since February and to protect our margins we may have to hike rates,” Raman said, adding his bank “will follow the market” before taking a call.
Companies fear that with money becoming more expensive, consumer demand and the investment plans could be the casualty.
Uday Phadke, president (finance, legal and financial services sector) and member of the group executive board at Mahindra and Mahindra Ltd, said the immediate impact could be a rise in interest rates for vehicle loans, “but with the promise of liquidity returning to markets, the overall credit availability and the affordability will hopefully stay within acceptable levels”.
A. Subba Rao, group chief financial officer of GMR Infrastructure Ltd, said, “Infrastructure projects that have large capex plans and have already begun operations” could see their profitability hit. Rao added that larger corporations might not step back from new projects because of their ability to raise capital, but smaller ones would be more circumspect and could adopt a wait-and-watch approach if the trend persists.
In a decidedly hawkish statement, RBI said “based on the current and evolving growth and inflation scenario” it is likely to persist with the current anti-inflationary stance.
The rate hike is expected to continue to rein in demand-side inflationary pressures while “minimizing risks to growth”, and manage the spillover of food and commodity-led inflationary expectations into more generalized inflation. While RBI’s focus in the third quarter monetary policy in January was overwhelmingly on containing inflation, this time around the Indian central bank has shown its concerns to the downside risks to growth as well, but made it clear that on balance, high inflation is a bigger threat than moderation in growth.
Indeed, the lead indicators point out that growth momentum persists, but “continuing uncertainty about energy and commodity prices may vitiate the investment climate, posing a threat to the current growth trajectory”, RBI said.
Economists said RBI’s action was on expected lines and that there could be a further policy rate hike of 50-75 bps later in the year.
They also insist that RBI governor D. Subbarao’s oft-mentioned “calibrated” approach towards rate tightening is missing in the policy document and this could mean that the central bank may become more aggressive in its rate tightening cycle in the next fiscal that begins in April.
“The statement was indeed hawkish,” noted Leif Lybecker Eskesen, chief economist for India and Asean at HSBC Global Research in Singapore. “RBI would now appear even more concerned about the inflation outlook.”
“...RBI is concerned that they are going to fight a lonely battle against inflation. They are basically not convinced that the FY12 Budget in the end will do its bit in terms of demand management, adding to the challenge of containing inflation,” Eskesen said, adding that the repo rate would go to 7.5% by end-2011.
“The statement mentions both the risk to growth as well as the high commodity prices, which means the balancing act for RBI is getting more difficult,” said Sonal Varma, India economist at Nomura Financial Advisory and Securities (India) Pvt. Ltd.
According to Varma, such rate hikes may affect growth, which is already under pressure because of other factors as high inflation, likely moderation in agriculture growth and lower fiscal policy support compared with last year.
Rohini Malkani and Anushka Shah, economists with Citibank India, in a Thursday report said, “We expect rates to be tightened by 75 bps by early 2012. But upside risks to inflation could result in front-loading and perhaps an extension of the rate hike cycle.”
Following the hawkish stance, and the government’s Rs3.43 trillion borrowing plan next fiscal, bond traders expect bond yields to go up in the near term.
Ashish Parthasarthy, treasurer at HDFC Bank Ltd, said yields on the 10-year bond may go up as much as 8.25% in the next three months. This is currently at 7.95%.
Graphic by Ahmed Raza Khan/Mint
John Satish Kumar contributed to this story.