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The Reserve Bank of India (RBI), after a surprise off-cycle policy meeting, announced to hike repo rate by 40 basis points to 4.40%. The move spooked the markets, catching traders off guard as Sensex slumped over 1,300 points.

The move is seen to be withdrawal of ultra loose monetary policy that was put in place since the pandemic began. However, as inflation soared and amid uncertain geo-political situation, the Central Bank said it will focus on withdrawing the accommodative stance too in the near future.

India's headline inflation print came in near 7% in March, staying above the Reserve Bank's comfort zone for the third straight month. Governor Shaktikanta Das said the April print is also expected to remain elevated.

"The monetary policy committee expects inflation to rule at elevated levels, warranting resolute and calibrated steps to anchor inflation expectations and contain second round effects," Das said in policy statement Wednesday.

Persistent inflation pressures are becoming more acute, particularly on food, Governor Shaktikanta Das said in an online briefing, adding that there is a risk prices stay at this level for “too long" and expectations become unanchored.

The central bank also increased the cash reserve ratio by 50 basis points to 4.5%, which will force lenders to park more money with the central bank and leave them with less to loan to consumers. Das said that would drain 870 billion rupees ($11.4 billion) of liquidity from the banking system.

Yields on the benchmark 10-year bond jumped as much as 30 basis points to 7.42%, the highest since 2019, while the main stocks index fell to a near two-month low. The rupee was up 0.1%, the second best performer in Asia for the day, as the higher rates lent the currency some additional support.

RBI policymakers had recently begun signaling that higher rates were in the works, after drawing fire from some economists for being too slow to react as consumer prices breached the upper limit of the bank’s target through the first quarter of 2022.

The move also comes ahead of the Federal Reserve’s rate decision on Wednesday, which is expected to see the US central bank’s most aggressive action to battle inflation in decades.

"Inflation and rate hikes are in the air. RBI did feel the heat lately and they took the markets by surprise by hiking rates across repo and CRR. We have lately seen large FMCG companies feeling the heat across their bottom-line which is clearly reflected in their prices and communication. The market was expecting a rate hike by RBI but in a slower pace, in fact the overnight indexed swap (1 yr 5 yr) were already pricing 100-140 bps hikes in a year," said Abhishek Goenka, Founder CEO of IFA Global.

"Front loading of the rate hike cycle will happen in the next 2-3 months. We feel by the end we should be closer to 5.15% - June 2023," he added.

"This policy rate hike will translate into higher EMIs for home loans. However, we believe that improved homebuyer attitude, preference for owning a house and strong wage growth will continue to support the housing market. The monetary policy stance is still accommodative and with the receding pandemic and economic growth, we expect that consumer demand will remain buoyant in the near term," said Gulam Zia, Senior Executive Director at Knight Frank India.

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