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RBI shocks with 50 bps rate hike

RBI shocks with 50 bps rate hike
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First Published: Wed, Jul 27 2011. 01 15 AM IST

RBI governor D. Subbarao (C) with deputy governors (L-R) H. R. Khan, K. C. Chakrabarty, Subir Gokarn and Anand Sinha before the RBI’s credit policy review meeting in Mumbai on Tuesday. PTI Photo
RBI governor D. Subbarao (C) with deputy governors (L-R) H. R. Khan, K. C. Chakrabarty, Subir Gokarn and Anand Sinha before the RBI’s credit policy review meeting in Mumbai on Tuesday. PTI Photo
Updated: Wed, Jul 27 2011. 04 42 PM IST
Mumbai: Corporate and individual loans will become more expensive after the Reserve Bank of India (RBI) on Tuesday surprised the market with a half percentage point hike in its policy rate to reign in high inflation, even as it highlighted the government’s own inadequacy to tackle what has been, for well over a year now, the country’s most pressing macroeconomic problem.
Companies and industry lobbies said the move will crimp growth.
The central bank also remained non-committal on its future action and said the stance of the policy will change only after a “sustainable downturn” in inflation.
Following Tuesday’s rate hike, the 11th since March 2010, RBI’s key policy rate has gone up by 4.75 percentage points to 8%. Most analysts expect at least one more rate hike by October, when RBI announces its second quarterly monetary policy review, and it could happen even earlier.
Bond prices dropped and yield on the 10-year benchmark bond jumped 13 basis points (bps) after RBI announced the rate hike, after opening at 2 bps higher than Monday’s close. One basis point is one-hundredth of a percentage point. It finally closed at 8.44% against Monday’s close of 8.29%. Bond dealers expect the yield on the 10-year paper to rise to 8.5%.
The impact on the equity market was equally severe. The 30-share Sensex, the benchmark index of BSE, fell 1.87% to close at 18,518.22 points, while the broad-based 50- stock Nifty of the National Stock Exchange lost 1.86% to end at 5,574.85 points. Interest rate-sensitive sectors bore the brunt of the rate hike, with BSE’s realty index falling 3.55%, the banking index losing 2.46% and the auto index declining 2.14%.
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RBI said that while it has seen some moderation in growth, consumption remains buoyant, and inflation remains persistently high. This is why it has raised its year-end inflation projection from 6% with an upward bias to 7%, but left the growth projection for the fiscal year unchanged at 8%.
‘Hurt future prospects’
“With the growth momentum already under pressure, this move (the rate hike) will further hurt the future prospects,” said Rajiv Kumar , secretary general of industry lobby Federation of Indian Chambers of Commerce and Industry.
V. Ashok, chief financial officer (CFO) of the diversified Essar Group, said that in an era of volatile commodity prices and shorter business cycles, continuous hikes in costs of borrowing would hit the profits of companies. “It is unlikely that we have seen the beginning of the end as far as hikes are concerned and clearly gloomy days are ahead for corporates in the short and medium terms,” he said.
RBI governor D. Subbarao (C) with deputy governors (L-R) H. R. Khan, K. C. Chakrabarty, Subir Gokarn and Anand Sinha before the RBI’s credit policy review meeting in Mumbai on Tuesday. PTI Photo
Y.M. Deosthalee, CFO of India’s largest engineering firm Larsen and Toubro Ltd, however, supported RBI’s move and said that from a long-term perspective, there will be no significant impact. “It’s only a few consumption-oriented sectors that the central bank is trying to cool down, but small and medium industries could be affected due to the rising cost of borrowing,” he added.
Aditya Birla Nuvo Ltd’s CFO Sushil Agarwal, too, said: “growth contraction seems more likely in the short term”.
RBI’s policy statement said it hiked rates to “maintain the credibility of the commitment of monetary policy to controlling inflation” and “reinforce the point that in the absence of complementary policy responses on both demand and supply sides, stronger monetary policy actions are required”.
Finance minister Pranab Mukherjee welcomed the policy move and said it “has sought to give a strong signal to further moderate inflation and check inflationary expectations”.
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In a statement after the policy, Mukherjee said notwithstanding some slowdown of gross domestic product (GDP) growth in the first quarter of 2011-12, as reflected in some indicators including the Index of Industrial Production and moderation in the growth of interest-sensitive sectors, the overall GDP growth for 2011-12 so far is in line with the momentum attained in 2010-11.
Loan rates to rise
At a post-policy meet with the media, most banks said they would pass on the rate hike to customers.
Yes Bank Ltd hiked its lending rate by 50 bps soon after the policy announcement, but others did not commit any time frame for raising their loan rates and deposit rates.
“We will all examine a rate hike. Yes, the interest rate will go up. But I won’t be able to tell you by how much,” said HDFC Bank Ltd’s managing director Aditya Puri.
According to Pratip Chaudhuri, chairman of India’s largest lender State Bank of India, interest rates on the longer tenure deposits may not go up, but there is a case for hiking short-term deposit rates. He declined to say when his bank would hike loan rates.
Chanda Kochhar, managing director and chief executive officer of India’s largest private lender?ICICI?Bank?Ltd, said RBI’s past policy actions have led to an increase in deposit and lending rates. “... Banks would review the movement in funding costs and effect further increases in lending rates based on the same,” she said.
Kochhar also said there have been some signs of moderation in credit growth. From 21.3% in March, banks’ year-on-year loan growth has marginally come down to 19.5% in July, but it is still higher than RBI’s projection of 19%. The banking regulator wants credit growth to come down to 18%.
Along with a revision in credit growth, RBI has also pared the money supply, or M3, growth to 15.5% from its April projection of 16%. Excess money in the system fuels inflation.
Most banks have recently, some even in the last week, hiked their loan rates. Another round of hikes will make money more expensive and dent growth in loans; at the same time banks run the risk of growing bad debts. When the cost of a loan goes up, companies with relatively weaker financials may find it difficult to service it.
Focus on inflation
High inflation has been a worry for the Indian central bank for several months. While wholesale price inflation continues to remain above 9%, non-food manufacturing inflation has remained above 7% for months.
What is particularly worrying RBI is that inflation is not only coming from supply-side constraints, like international commodity prices, but also from “strong demand pressures”.
A higher interest rate makes money costlier and limits the ability of customers to purchase goods, thereby reducing demand pressures, but RBI does not seem to be very hopeful about inflation coming down anytime soon. International commodity prices, particularly crude prices, remain high and pose a major threat, RBI noted, while cautioning that “there is still an element of suppressed inflation in the economy”.
Graphic by Ahmed Raza Khan/Mint
Ashwin Ramarathinam and John Satish Kumar in Mumbai, and Remya Nair in New Delhi contributed to this story.
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First Published: Wed, Jul 27 2011. 01 15 AM IST
More Topics: RBI | Repo Rate | Inflation | Monetary Policy | Growth |