RBI Hikes Key Interest Rate In A Sudden Surprise Move Amid Intensifying Inflation

RBI Hikes Key Interest Rate In A Sudden Surprise Move Amid Intensifying Inflation
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In a surprising decision Wednesday, India’s central bank upped its key policy rate, sending bond yields higher as it strengthened the fight against inflation, outperforming expectations for much of the year.

The Reserve Bank of India upped its repurchase rate to 4.40 per cent, from the record low 4 per cent it had been held at for the past two years, to boost the economy in its first unannounced rate change since the pandemic’s peak.

Governor Shaktikanta Das stated in an online briefing that persistent inflation pressures are getting more acute and that there is a risk that prices would linger at this level for “too long,” causing expectations to become unanchored. The next planned rate decision by the bank is not until June 8.

As consumer prices surpassed the upper limit of the bank’s target in the first quarter of 2022, RBI policymakers began suggesting that higher rates were on the way.

The move comes ahead of the Federal Reserve’s rate decision on Wednesday, when the central bank is poised to take its most severe anti-inflation measure in decades.

For much of this year, gasoline and food prices have been greater than the RBI had anticipated, worsened by Russia’s invasion of Ukraine and ongoing pandemic-related supply chain bottlenecks. For the third month in a row, headline inflation hit a 17-month high of 6.95 per cent, exceeding the Reserve Bank of India’s target range of 2% to 6%.

Following a reaffirmation of its accommodative approach in February, which some economists criticized as being overly lenient on the risk of increasing prices, the central bank announced this month that it would begin prioritizing inflation over growth support.

Since then, traders have begun pricing in the region’s most aggressive rate hikes. As Das spoke, the yield on the benchmark 10-year bond surged 28 basis points.

 “The inflationary risks warrant a more aggressive and earlier tightening of monetary policy,” Nathan Sribalasundaram, India rates analyst at Nomura Holdings Inc. in Singapore, said before the briefing.

Jayanth Rama Varma, one of the most hawkish members of the RBI’s rate-setting committee, hinted that the bank was willing to raise borrowing prices in an interview late last month. He stated, “All the groundwork has been laid.” “Liquidity has normalized, forward guidance has been removed, and we are now entirely free to act.”

Shashanka Bhide, a member of the Monetary Policy Committee, said in a separate interview that the spike in food prices had startled officials.

The RBI boosted its inflation projection for the fiscal year that began on April 1 to 5.7%, up from 4.5% in February and said it expects gross domestic product growth of 7.2%, compared to a previous estimate of 7.2%t.

Bankers and experts predict that interest rates on home, vehicle, and small business loans will rise in the coming months as banks pass on the impact of the repo rate hike to end borrowers.

The Reserve Bank of India (RBI) manages inflation in the economy by manipulating interest rates. Inflation usually rises when the economy’s demand exceeds its supply, causing prices to rise. As a result, the RBI will raise the repo rate to control demand, making it more expensive for banks to borrow from them. On the other hand, banks have the option of passing the rate increase on to borrowers.

In the event of rising interest rates, borrowers can expect to pay higher equivalent monthly payments on their loans, reducing their purchasing power, according to bankers and economists. This is largely because interest rates on loans are expected to rise soon. Whether they are for a home, a car, or a personal loan, all retail loans are expected to grow more expensive.

“By raising rates aggressively, the RBI has indicated that the policy stance is hawkish. This will feed into the entire complex of interest rates from fixed deposits to deposit rates,” said Varun Khandelwal, director and fund manager at Bullero Capital.

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Existing borrowers will be hit the most, according to analysts, because the majority of house loans have an adjustable rate. The impact of a rate hike is directly passed on to the borrower in these loans. According to the RBI’s requirement, any floating rate house loans obtained after October 1, 2019, must be tied to an external benchmark, which means that current borrowers should expect to pay more each month.

In this situation, lenders will usually extend the loan’s term rather than increase the EMI amount. In the long term, this is not cost-effective for the borrower.

“Given that a large section of the loan has now been linked with the external benchmark, that transmission will be fast for existing borrowers,” said Soumyajit Niyogi, Director, Core Analytical Group, India Ratings & Research.

According to specialists, new borrowers should try to get their loans released as soon as possible before banks start raising interest rates. This will go a long way toward keeping the rate low during the loan’s term, even if the total interest rate rises.

Interest rates are expected to climb, which means fixed deposit rates will also rise. A fixed deposit (FD) is a financial instrument offered by lenders that pays a higher interest rate to investors than conventional savings account until the specified maturity date. Banks will now be required to pass on the benefits of higher interest rates to depositors.

Banking analysts predict that FD rates will be re-priced following the RBI’s repo rate hike.

“Depositors should consider locking funds in shorter-duration FDs to benefit from higher interest rates in the coming months,” said a banker at a private bank.

The repo rate hike directly impacts the bond market or the cost of borrowing cash for both the government and corporations. The 10-year benchmark bond yield surged 7.38 per cent after the repo rate hike, the highest level in three years. Money market experts believe the unplanned policy meeting and the scale of the rate hike indicate that the central bank may opt for aggressive rate hikes in the following months to keep inflation under control.

“The sudden announcement is a surprise to the market even though we expected a 50 bps repo hike in the forthcoming monetary policy. Now it is to be seen whether the RBI will further hike in the coming policy,” Venkatakrishnan Srinivasan, founder, and managing partner at Rockfort Fincap, a Mumbai-based debt advisory firm.

“With the sudden hawkish tilt, the cost of borrowing for corporate bond issuers will increase drastically,” Srinivasan said.

According to analysts, the RBI would have to calm bond market jitters by engaging in open market operations to reduce market volatility and keep the bond yield curve from steepening further. “Unless that happens, the 10-year g-sec rate will rise above 8% shortly,” a treasury head of a state-run bank said on condition of anonymity.

Also Read: FD Alert! ICICI Bank Increases Interest Rates On Fixed Deposits


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