The Reserve Bank of India’s financial year-end rate hike has shocked and surprised parts of the market, but leading bankers and economists say the central bank is not yet through with its rate hike cycle and it could yet raise short-term policy rates by another 25-50 basis points.
One basis point is one-hundredth of a percentage point.
However, with the US Federal Reserve pressing the pause button on its interest rate thinking and the impact of its own past actions slowly being felt, the Indian banking regulator may stop hiking rates in the later part of this fiscal year, these RBI observers say.
In a report titled “RBI loses its cool, adopts unnecessary shock therapy,” released over the weekend, Rajeev Malik, an economist with JP Morgan Chase Bank’s Asia economic research, expects “RBI to keep interest rates unchanged,” though another raise in banks’ cash reserve ratio (CRR) “cannot be ruled out.”
“We were expecting a rate hike in April. So, we were surprised to see a rate hike in the last week of the year. And it was a double shock to see the CRR hike as well,” says Sandeep Bhandari, head, global markets, for South Asia at Standard Chartered Bank. “This is a signal that RBI thinks the previous hikes have not done enough and it wants to give a strong jerk to slow things down.”
The $7 billion outflow as advance tax payments during a rate hike cycle sent overnight rates soaring in March. The market had expected liquidity to ease as funding for the new year’s budgetary allocations flowed into the system.
But, with inflation remaining high at 6.5%, against RBI’s projection of 5-5.5%, and credit growth not coming down enough, it announced a hike in short-term rate as well as CRR on 30 March.
“As dollar flows and budgetary allocations come in, there could be some respite. But RBI wants to keep a check on liquidity keeping that in mind,” says Indranil Pan, chief economist, at Kotak Mahindra Bank.
Another senior economist with a large corporate group in Mumbai, who does not wish to named, says he believes at least one more rate hike is round the corner. “It may not happen in April but clearly RBI is on high alert,” he says.
“As long as the spectre of inflation is there, RBI will have to keep rates tight,” says D.K. Joshi, senior economist at credit ratings agency Crisil. Despite a range of measures to regulate the supply of food items, where prices have risen most, control the real-estate market and demand for credit, inflation has remained high.
“It takes more than one year for the impact of rate hikes to really be felt, so RBI has to be very proactive and rightly so,” Joshi says.
Credit growth has come down marginally since the beginning of the rate hike cycle but remains “above RBI’s comfort zone”, says Kotak’s Pan. All these suggest there is room for one more rate hike, although it may not come in the April credit policy.
The latest rate hike will lead to the yield curve in government bonds getting flatter, “which is indicative of economic slowdown,” says Devina Mehra, chairperson of First Global, a brokerage. Call rates could open as much as 30% and 10-year government security yield could go up 8.15- 8.3%. “The three-year and five-year bonds will be most affected but, over the longer term, the 10-year bond will also rise. People would not want to buy the 10-year bond unless RBI’s stance becomes clear,” points out a bond dealer with a foreign bank.
This will also affect corporate earnings as banks will raise lending rates and this will curb consumer demand. India’s largest private bank, ICICI Bank, took the lead over the weekend and raised its lending rates. “Earnings growth could moderate from 30-40% this year,” Mehra says. “The cost of capital will go up. So, while capacity utilization has been high, building new capacity is getting harder.”
All these mean that drivers for the stock market are negative for the next fiscal year, she adds.
Inflation is expected to come down later this year as the impact of RBI rate hikes is felt. The base effect is also likely to bring down inflation figures. Also, the government’s range of measures to curb the real-estate market and food supplies are expected to have an impact.