RBI's first in four and half years, interest rates hiked by 25 basis points; Start of a tightening cycle of rates?

Last Updated: Wed, Jun 06, 2018 17:56 hrs
RBI (Reuters image)

Mumbai: The three-day monetary policy meeting, expected to announce its decision on interest rates, on Wednesday concluded in a rate-hike.

The six-member committee unanimously agreed to a 25 basis point or 0.25% hike, upgrading repo rates at 6.25% and reverse repo rates at 6%.

The official release of the Central Bank reads, "On the basis of an assessment of the current and evolving macroeconomic situation at its meeting today, the Monetary Policy Committee (MPC) decided to increase the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points to 6.25%."

"Consequently, the reverse repo rate under the LAF stands adjusted to 6.0%, and the marginal standing facility (MSF) rate and the Bank Rate to 6.50%," reads the release.

The rate at which the Reserve Bank of India lends money to commercial banks is known as repo rate while the reverse repo rate is the rate at which the central bank of borrows money from commercial banks within the country.

The last rate hike was announced by RBI in January 2014 when the repo rate was increased to 8%.

Since then, the central bank has either reduced the rate or maintained status quo. The six-member team voted in unison for a rate hike. The RBI' release confirms Dr. Chetan Ghate, Dr. Pami Dua, Dr. Ravindra H. Dholakia, Dr. Michael Debabrata Patra, Dr. Viral V. Acharya and Dr. Urjit R. Patel voted in favour of the decision.

The release also elaborated on the reasons for a rate hike. Since its last meeting held in April, the MPC found economies of most countries growing or showing stable results. The MPC averred that economies such as the US had shown improvement in its employment data and there was a strong retail sales. Euro growth decelerated in Q1 and business sentiment suggested a loss of pace.

Economies in South Africa, China have been stable and the only concern was around Brazil. In contrast, a stream of poor data from Brazil on high unemployment and soft industrial production show that the effects of recession linger.

The RBI MPC release added "on the domestic front, the Central Statistics Office (CSO) released on May 31 the quarterly estimates of national income accounts for Q4:2017-18 and provisional estimates for 2017-18.

Gross domestic product (GDP) growth for 2017-18 has been estimated at 6.7% up by 0.1 percentage point from the second advance estimates released on February 28. This increase in growth has been underpinned by a significant upward revision in private final consumption expenditure (PFCE) due especially to improved rural demand on the back of a bumper harvest and the government’s thrust on rural housing and infrastructure. Quarterly data suggest that the economy grew at 7.7% in fourth quarter of fiscal year 2017-18 – the fastest pace in the last seven quarters. Gross fixed capital formation (GFCF) growth accelerated for three consecutive quarters up to Q4.

Monsoon & Agriculture

On the supply side, estimates of agriculture and allied activities have been revised upwards, supported by an all-time high production of foodgrains and horticulture during the year. On a quarterly basis, agriculture growth increased sharply during the fourth quarter of the fiscal year 2017-18. On April 16, the India Meteorological Department (IMD) forecast a normal south-west monsoon rainfall, which was reaffirmed on May 30. This augurs well for the agricultural sector.

Industry Thoughts & Views:

Anita Gandhi, Whole Time Director at Arihant Capital Markets said that the Recent hike in crude prices and better GDP for last quarter of FY 18 suggest inflation trajectory "may be on the higher side. Though, this may put some pressure on borrowers, it is positive news for the savers in the economy."

VK Sharma, Head for Capital Market strategy at HDFC Bank shared in a note that the central bank's decision was a step in the right direction. "The policy is hawkish on inflation but we like the confidence shown in the economy growth. Despite inflationary pressures RBI has stuck to its growth projections and guided for robust investment activities for FY19. Despite the hike, the stance is still neutral , which is good. This puts RBI ahead of the curve," he said.

George Alexander Muthoot, the Managing Director at Muthoot Finance too welcomed RBI`s decision to increase the rates. "Given the inflationary pressure and rising food and fuel prices, this move looks positive for the economy. The rate hike gives a clear hint to India Inc to push for growth, take investment decisions as it can now foresee growth rate to pick up," he said.

Umesh Revankar, MD & CEO of Shriram Transport Finance, a leading player in the sectors of transport and finance shared in a note, "Signs of growth like accelerated commercial vehicle sales, improving sales of tractors and two-wheelers in April are encouraging. With the expectation of good rainfall this year, we expect rural demand to pick up on increased food grain production and consumption. This will further help in strengthening the sales of commercial vehicle. Construction activity has seen record highest growth in Q4 in the new series since 2011-12. This will add momentum and help in economic growth.”

Real Estate:

A rate hike is likely to increase rates for housing loan, and may impact consumer spending. Shishir Baijal Chairman and Managing Director explained in a note. He said, "The RBI’s stance of increasing the policy rate by 25bps is in line with our expectation considering that the crude oil flared inflation level and the interest rates in the broader economy have been marching higher for some time now."

"However, this increase in policy rate will delay the revival of the country’s housing market, which after suffering a prolonged period of slump has just begun to show early signs of improvement on account of uptick in affordable housing," he added.

Adhil Shetty, the Co-founder and CEO of BankBazaar said that the decision was on expected lines and was a well-thought precautionary move "to stay ahead against the backdrop of global volatility in crude and elevated commodity inflation worldwide."

He advised that existing borrowers may not immediately witness any change in their EMIs, but a higher interest rate would eventually increase the long-term interest out-go. "One of the ways to protect yourself is by making a pre-payment that would lower your overall interest outgo. This would be particularly a good move for those at the beginning of their loan tenure," he said.

He further elaborated that for those nearing the end of loan, "it is wise not to take any steps and simply maintain the loan till the end of its tenure to collect any useful tax deductions."

"Simultaneously, you can also increase your savings or step up your investments to pre-pay your loan so that the interest outflow is not as high," he added.

Bond Yields

Dhananjay Sinha, an Economist from Emkay Global Financial Services averred that the rate hike was a precursor to a tightening in rate cycles.

"The announcement of 25bp rate hike by RBI today broadly encompasses considerations of upside revision in inflation trajectory going ahead, impact of rising commodity prices and rising global yields, led by tightening of US dollar liquidity. With this hike the RBI has finally reversed the 25bp cut it initiated in Aug’17, while retaining neutral stance, in the aftermath of demonetisation and impact of GST implementation, which led to surplus liquidity condition. Even With this rate hike the stance is still not of tightening. In our view, this rate hike could lead to a tightening stance if the inflation risks accentuate along with currency depreciation," he said.

There has been a section of analysts suggesting the RBI may hike the rate by another 25 basis points in its next meet. Suvodeep Rakshit, a Sr. Economist with Kotak Institutional Equities, explained in a note, “We remain confident that this will be a shallow rate hike cycle if the present conditions do not deteriorate significantly."

"We expect the RBI to hike by another 25 bps in the August policy but the call will hinge on how crude and INR movements pan out over the next few months, as well as, the extent of MSP hikes. We need to carefully look at the RBI minutes and observe the extent of upward pressure on food prices in the near term, risks of fiscal slippages, domestic growth recovery, and evolving global macro conditions (trade wars, DM monetary policy cycle, and commodity prices) to have greater clarity on the extent of RBI’s rate hike cycle," read the note.

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