The 40 basis points (bps) hike in the benchmark repo rate of the Reserve Bank od India (RBI) after the off-cycle meeting of the central bank’s monetary policy committee or MPC will lead to a rise in EMIs. However, experts assess that this is just the start of a trend of upward revision of the repo rate, or the rate at which the RBI lends to banks. The experts also feel that by the end of March 2023, the repo rate may reach 5.15%. This amounts to a predicted rise of 75 bps in the next 10 months.
This means that over the next year, there may be some good news and some bad news as a higher repo rate may mean bring more income from bank deposits but will also lead to a significant increase in Equated Monthly Installments for borrowers.
WHAT SBI’s ECOWRAP SAYS
In its latest Ecowrap, the SBI’s economic research unit said that as of December 2021, around 39.2% of the loans were linked to external benchmarks and the increase in repo rate will eventually push up interest costs for consumers and may show its impact from the next quarter.
Diagnosing the inflationary trends that led to the RBI intervention the report said that inflationary pressure can be attributed mainly to the adverse cost-push factors, coming from the supply-side shocks in food and fuel prices. The report recommended that measures to ameliorate the supply-side cost pressures would be critical at this juncture, especially in terms of a calibrated reduction of taxes on petrol and diesel.
The report says a calibrated reduction in fuel prices would help anchor inflation expectations, prevent build-up of a wage-price nexus, and provide space for the monetary policy to sustain support for the still incomplete growth recovery. On the policy side, it would mean that even after rate hikes, inflation may continue to remain high for some time.
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However, the report added that the RBI’s intervention on Wednesday was in sync with measures announced in 21 countries where interest rates have been increased so far in April and May this year. Of these 21 countries, 14 hiked their repo rates by at least 50 bps. Markets are also expecting the biggest upheaval since 2000 after a 50 bps hike by the US Federal Reserve.
The Ecowrap stated that though the share of MCLR-linked (marginal cost of funds based lending rate) loans has declined over a period, it still is a major constituent at around 53%.
‘MCLR MAY RISE MARGINALLY’
The RBI had hiked the cash reserve ratio or CRR by 50 bps. The report stated that with the rise in CRR and the expected hike in the benchmark rates, there would be a marginal increase in MCLR due to negative carry. Further, if banks raise the deposit rates then the cost of funds (COF) will increase and subsequently MCLR will rise. Interestingly report adds that the rise in CRR by 50 bps will suck out system liquidity by an additional Rs 87,000 crore.
This report’s evaluation that the RBI may step in with more hikes in repo rate is based on “RBI’s emphasis that monetary policy remains accommodative and will be focused on a careful and calibrated withdrawal of pandemic-related extraordinary measures, keeping in mind the inflation-growth dynamics.”
Soumya Kanti Ghosh, SBI group’s Chief Economic Advisor, said that the RBI’s intervention came after the “realization of siding with changing realms of inflation control gained currency. This had been palpable for some time as economies from developed as well as emerging worlds were struggling to rein in the galloping price rises that hurt the masses and, probably, classes alike.
Ghosh said that with the current increase in the repo rate, the standing deposit facility (SDF) rate now stands adjusted to 4.15% and the marginal standing facility (MSF) rate and the bank rate to 4.65%, maintaining the liquidity adjustment facility corridor.
The Ecowrap assessed that the MPC intervention reflects a pragmatic approach as it ensured that inflation remained within the target going forward while supporting growth. The report backs the RBI’s approach by terming it “flexible” in choosing the most suitable tool for addressing the most persisting issue.
‘INFLATION CONCERNS HERE TO STAY’
The Ecowrap, putting its finger on the key reason behind the intervention, stated that there was a realisation that inflationary concerns are non-transitory. This means that they are here to stay for some time.
On April 8, the central bank MPC decided to keep the rate unchanged at 4%. There was a perception that the RBI is persistent with an accommodative stance aimed at growth was based on an assessment that inflation was within control and was not hardening for a longer stay the RBI moves comes days after central banks all over the world switched gears from pausing the “accommodative stance” or policies promoting the release of liquidity and credit for reviving growth hit by the pandemic to “sucking the gushing liquidity unleashed during pandemic” to control shooting prices.
Reviewing the responses across the globe, the Ecowrap said that the US Federal Reserve has taken one of the most aggressive stances as it departed from bond purchases while announcing steep hikes to rein in spiralling prices. It underlines that countries in the European Union are steadfastly gearing up to step up the throttle while emerging economies like Brazil and Russia are embracing key rates in double digits. This, according to the report, indicated an all-out war by nations, facing elevated energy and commodity prices that are expected to remain high for more time than anticipated earlier.
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The hike of 40 bps in repo rate to 4.4% by the RBI has driven the rate cycle to a U-turn (from the steep cuts seen in early 2020). But the Ghosh said, “We believe this simultaneous policy announcement of adjusting both the rate and quantum of liquidity is a clever ploy and reinforces the credibility and reputation of the central bank. The CRR hike could also open up space for open market operations (OMO) purchases by RBI.
‘REPO RATE HIKE GOOD FOR BANKING SECTOR’
Highlighting the benefits of the policies pursued in the post-pandemic period the report says that the push to align retail and MSME loans with external benchmarks of late ensured a growing proportion of borrowers to side with External Benchmark based Lending Rate-linked (EBLR) loans whose share in advances have gone up to 39%.
It adds that banks, that already have wafer-thin margins in retail loans, have little incentive in not passing, to a great extent, the present and future hikes to customers whose EMIs should undergo upward revision. If banks raise the deposit rates then the cost of funds (CoF) will increase and subsequently MCLR will increase too.
“We believe the decision of rate hike will be ultimately good for the banking sector as the risk is being realigned properly. The situation is different from what it was during the global financial crisis wherein lending started increasing aggressively (FY05 onwards), much before the rate hike cycle began (Mar’2010 till Oct’2011). Currently, the rate-hike cycle has begun and now the bank lending will increase, factoring in the risk,” the report read.
As per the report, the system liquidity is still in surplus mode with net durable liquidity at Rs 7.2 lakh crore as of May 2, 2022. The RBI is likely to absorb Rs 87,000 crore of liquidity from the market on a durable basis through the CRR hike announced on Wednesday. High government borrowing has ruled out the possibility of Open Market Operations (OMO) sales. Thus, CRR increase seemed the most plausible non-disruptive option for absorbing the durable liquidity.
The report predicted that this would open up space for the RBI to conduct liquidity management in future through OMO purchases to address duration supply while absorbing some part of the durable liquidity.
In contrast to the developed world, the report stated, nominal rural wages for both agricultural and non-agricultural labourers in India picked up during H2 of FY22, with easing of restrictions and lockdowns imposed by states and restoration of economic activity. However, the wage growth remained soft. The weighted contribution of wage growth in CPI build-up remains modest. Thus, even after rate hikes, inflation will take time to moderate.
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