Mumbai: The Reserve Bank of India (RBI) on Thursday raised its key policy rate by a quarter percentage point to 7.5%, in line with market expectations, and continuing its fight against inflation in the world’s second fastest growing major economy.
This will make money costlier and impact growth, something RBI is conscious of. The central bank’s mid-quarter monetary policy review said the policy stance remains “firmly anti-inflationary” even at the cost of slowing growth in the “short run”.
Most economists expect RBI to continue with its rate-tightening cycle as wholesale price inflation, which was 9.06% in May, is likely to remain above the central bank’s “comfort zone” for months to come. But bond dealers say slowing global growth may not allow RBI to remain aggressive in its tightening stance.
The yield on the 10-year, 7.8% government security maturing in 2021 ended lower at 8.29% from the 8.4% close on Wednesday. The five-year benchmark swap rate ended at 7.66% against 7.89% a day ago.
The Bombay Stock Exchange’s bellwether equity index, the Sensex, shed 146.36 points, or 0.81%, to close at 17,985.88.
This is the 10th time since March 2010 that RBI has raised policy rates to fight inflation. With the latest round, the repo rate at which RBI lends to banks has gone up to 7.5%. The reverse repo rate, or the rate at which it drains excess liquidity from the system, is now 6.5%.
RBI’s rate action will make money dearer for individuals and corporations, and most banks are likely to raise loan rates, beginning next week.
Chanda Kochhar, managing director (MD) and chief executive officer of India’s largest private lender ICICI Bank Ltd, said the rate hike and “the prevailing systemic liquidity conditions could lead to an increase in funding costs for banks, and in lending rates”.
Also See | Continuing struggle (Graphic)
“Our lending rates will go up by at least a quarter percentage point and a decision in this regard will be taken in the next one or two days,” said S. Raman, chairman and MD of state-owned Canara Bank.
M. Narendra, chairman and MD of Indian Overseas Bank, also said his bank will raise loan rates. “We are left with no option, but to pass on the cost to the customer to maintain our margins,” he said.
Keki Mistry, vice-chairman and MD of Housing Development Finance Corp. Ltd, India’s oldest mortgage lender, said his firm will wait for a few days before taking a call. “Whenever market rates rise, our cost of funds also increases, but we will have to wait for two-three days before deciding,” he said.
Some of the bankers are also worried about the impact of higher rates on the investment climate. For instance, Canara Bank’s Raman said: “The real issue, however, is the deceleration in new investments, which can be a serious problem to banks in the next two quarters.”
ICICI Bank’s Kochhar, however, said, “Based on the trends across various segments and the existing pipeline of approved projects, credit growth for the year is expected to be in the range of 18-20%.”
Bank credit till early June has grown at 20.6% year-on-year, above RBI’s annual loan growth projection of 19%.
In the last six months, Indian banks have raised their loan rates by at least 150-200 basis points (bps) to pass on the burden of the central bank’s successive rate hikes to the customer kitty, in a bid to protect their margins. One basis point is one-hundredth of a percentage point. State Bank of India, the nation’s largest lender, has increased its minimum lending rate to 9.25% from 7.6% in December 2010.
RBI said though the impact of its past actions is “still unfolding”, the challenge of containing inflation and anchoring inflation expectations still persists. The latest policy action is expected to contain inflation by “reining in” demand pressures and “mitigate the risk to growth from potentially adverse global developments”, it said.
The central bank is particularly worried about the rise of so-called core inflation, or non-food manufacturing inflation. Core inflation rose from 6.3% in April to 7.3% in May.
Finance minister Pranab Mukherjee endorsed the RBI action, saying “there was a need to have a better price stability for sustaining growth in the medium term”.
Most economists are expecting RBI to continue with its rate-tightening cycle even though there is no consensus on the pace and quantum of hike in coming months.
For instance, both Robert Prior-Wandesforde, head of India and South-East Asia economics at Credit Suisse, as well as Rajeev Malik, senior economist at CLSA Asia-Pacific Markets, said India’s policy rate will be raised by 50 bps to 8% during the year while Leif Lybecker Eskesen, chief economist for India and Asean at HSBC Global Research, Singapore, is betting on a 75 bps hike.
Nomura Financial Advisory and Securities’ India economist Sonal Varma expects a 25 bps rate hike to 7.75% on 26 July at RBI’s quarterly review of monetary policy. “Beyond that, we expect RBI to stay on hold while taking into account the lagged impact of its policy actions, as domestic growth concerns start to dominate and global growth concerns hopefully constrain commodity prices,” she wrote in her report on Thursday.
“We are looking for the last rate hike to come at the mid-September meeting, with the repo rate peaking at 8%,” Prior-Wandesforde said.
Malik, too, expects RBI to go for another 25 bps hike in July and said the latest “policy details do not alter our expectations of the repo rate increasing to 8% later in the year”.
Indranil Pan, chief economist at Kotak Mahindra Bank Ltd, said RBI has some more work to do given the core inflation is still firm. “Core inflation is a concern, but it is dependent on global commodity prices, which have a steady bias towards softening, given the slowdown in global growth. We expect the RBI to hike the policy rate twice further by 25 bps each,” he said.
“I feel that the RBI is likely to continue with its calibrated tightening until there are definite signs of inflation slowing down, but this may not be aggressive as there are clear signs of growth slowing down,” said Rupa Rege Nitsure, chief economist of Bank of Baroda.
Graphic by Paras Jain/Mint