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NEW DELHI : The Reserve Bank of India’s surprise interest rate hike, a month ahead of its next policy meeting, caught investors wrong-footed, prompting a selloff in stocks and bonds.

Benchmark indices Sensex and Nifty fell 2.29% each on Wednesday, the sharpest drop in nearly two months.

“It took everyone by surprise. The hike of 40bps is higher than the market expectation of 25bps in the June meeting," said Dhiraj Relli, managing director and chief executive of HDFC Securities. That apart, the increase in cash reserve ratio by 50 basis points to 4.5% will drain 87,000 crore of liquidity from the banking system, Relli added.

The announcement triggered a selloff in interest-rate sensitive stocks, including banks, automobiles and real estate.

“Coming ahead of the US Fed announcement due today (Wednesday), RBI has taken the lead for the time being, after being blamed for being behind the curve by some economists," Relli said. He expects stocks to remain under pressure for some time.

The bond markets, too, reacted negatively. India’s 10-year benchmark bond yield jumped to 7.42%, its highest since May 2019, right after the policy decision, while the rupee strengthened against the dollar to as much as 76.21. This indicates an imminent rise in cost of funds, said V.K. Vijayakumar, chief investment strategist at Geojit Financial Services.

“The bond markets witnessed a surgical strike moment with the surprise 40 bps repo rate hike and 50 bps CRR hike," said Lakshmi Iyer, chief investment officer (debt) and head products, Kotak Mahindra Asset Management Co. The draining of liquidity and expectations of continued rate hikes could mean elevated bond yields, Iyer said. She expects global factors such as the impending rate hike by the US Fed to also weigh on yields.

Experts are expecting a further rise in yields.

“We expect bond markets to react negatively and the entire yield curve to shift upwards (slightly more impact at the shorter end of the curve). Markets may trade cautiously in the near future as fiscal comfort also seems to be dwindling at a fast pace, said Akhil Mittal, senior fund manager- fixed income at Tata Mutual Fund.

The withdrawal of accommodative stance by RBI further dented sentiments, said Sanjeev Hota, head of research, Sharekhan by BNP Paribas. Hota expects stocks to remain volatile as the markets will take some time to absorb the sudden policy change. Investors will also keenly monitor the developments in the US, he added.

The Fed is widely expected to raise the interest rate by a half-percentage point. Investors will, however, be more focused on its commentary on future actions, experts said.

Mitul Shah, head of research at Reliance Securities, said the trend in global stock markets and the movement of the rupee and crude oil prices would dictate the market trend in the near term. For equities, inflation remains a key overhang, coupled with Russia’s lingering war with Europe and strict lockdowns in Shanghai, said Shah.

Meanwhile, the rate hike’s impact is likely to be significant on equity markets. The potential downside has increased, said Naveen Kulkarni, chief investment officer, Axis Securities.

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