Reserve Bank hikes key rates, signals a breather

Reserve Bank hikes key rates, signals a breather

Mumbai: The Reserve Bank of India (RBI) raised its policy rates for the sixth time this year, but added that further rate hikes were not likely in the immediate future.

The Indian central bank continues to be worried about the persistence of high inflation, though there are signs that core inflation—based on the prices of goods other than food—is falling in response to the tighter monetary policy since January.

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But the battle is far from won. Wholesale price inflation has come off its April peak of 11.23%, but was yet at 8.6% in September, well above the 6% RBI expects by the end of the current fiscal.

Following Tuesday’s move, the repo rate, or the rate at which RBI injects liquidity into the system, is at 6.25%, and the reverse repo rate, or the rate that is used to drain liquidity from the system, is at 5.25%.

However, individual and corporate borrowers may not be affected right away. Recent lending rate hikes by banks mean that borrowing costs are unlikely to go up until December. But banks may be forced to hike deposit rates more quickly because of the prevailing shortage in banking liquidity. Other than IDBI Bank Ltd, no other major commercial bank had increased deposit and lending rates by late Tuesday evening.

Finance minister Pranab Mukherjee said that while the interest rate hikes may have a small negative impact in the short term on economic growth, he hoped that the move would help growth in the medium term.

Bonds rallied despite the rate hike as dealers focused on the unexpected pause announced by RBI governor D. Subbarao. The most-traded 12-year bond rallied as its yield dropped to the lowest since September, to close six basis points down at 8.01%. Bond yields drop as prices go up.

“Based purely on current growth and inflation trends, the Reserve Bank believes that the likelihood of further rate actions in the immediate future is relatively low," Subbarao said in his policy statement.

“However," he clarified, that “in an uncertain world, we need to be prepared to respond appropriately to shocks that may emanate from either the global or domestic environment".

Later at a press conference, Subbarao said “immediate future" is three months.

“I am not ruling out any action in December or January, but we believe we will refrain (from hikes) if there is no unforeseen event," he said.

RBI will announce its mid-quarter policy on 16 December and the next quarterly policy is on 25 January.

The four-month overnight indexed swap rate fell by 10 basis points to 6.45% after the RBI policy announcement, to price in lower expectations of another rate rise before the end of the fiscal.

The new interest rate policy comes as developed countries such as the US and Japan are expected to go in for a second round of quantitative easing that will put in more money in the hands of the investors in developed markets. That extra money is expected to chase high returns and flood emerging markets economies (EMEs) such as India. The US Federal Reserve is expected to take a decision on this on Wednesday.

With the rate hike, the interest rate differential between the developed market and India will increase and yield-hungry foreign investors are likely to pump in more money into the system that can potentially stroke inflation.

“While the ultra-loose monetary policy of advanced economies may benefit the global economy in the medium term, in the short term it will trigger further capital inflows into EMEs and put upward pressure on global commodity prices," Subbarao said.

The Indian central bank also expressed concerns about the big rise in asset prices such as real estate, gold and shares.

RBI tried to take some fizz out of the housing market by increasing the standard asset provisioning for “teaser rates" loans to 2% from 0.4% now. That means even if the loan is good, banks have to set aside 2% of the loan value against 0.4% earlier. This makes lending costlier for banks.

In addition, banks have been told to give only 80% the value of a property as loans.

But Subbarao at the press conference also clarified that although the real estate prices have surpassed the pre-crisis level in the metros, “there is no bubble", but “certainly there is an asset price build up".

State Bank of India (SBI) chairman O.P. Bhatt told reporters that the measures on the “special housing loan rates", under which the bank gives loans at as low as 8% for the initial years, are unlikely to have any impact on SBI’s housing loan rates as the impact would be around 0.05-0.10% in cost for the bank.

“We may not need to increase home loan rates immediately," Bhatt told reporters.

Union Bank of India chairman and managing director M.V. Nair said lending rates are unlikely to increase this quarter because banks have recently revised their base rates, which they charge their best borrowers and act as a benchmark for other loans.

“However, the impact of the repo rate could pass on to the deposit rates, which will impact the base rate in the next quarter," said Nair.

ICICI Bank Ltd chief executive Chanda Kochhar said rates may not go up immediately as credit demand is still sluggish. “Depending on the credit pickup, there may be an upward bias on interest rates," she said.

Subbarao also indicated in his policy statement that RBI would have to “actively manage liquidity to ensure that it remains broadly in balance, with neither a surplus diluting monetary transmission nor a deficit choking off funds flow".

Dinesh Unnikrishnan and Reuters also contributed to this story.