Jan. 29--The Reserve Bank of India (RBI) surprised the markets by raising the repo rate -- the rate at which the central bank lends to the banking system for the short term -- by 25 basis points (bps) to 8%. One basis point is one-hundredth of a percentage point.
The stock market, which after witnessing a significant amount of volatility due to global factors during the last two sessions, was holding up in the green with an expectation of a status quo on the policy front. It quickly slipped into the red after the announcement, though it recovered later. At the end of the day's trade, the S&P BSE Sensex was down 23.94 points, while the S&P BSE Bankex lost 36.58 points.
The reasoning in the market was that in the mid-quarter review of the monetary policy in December, RBI had left the rates unchanged and had argued that it will wait for more data before taking a call on the policy rates. Since the inflation reading for December came in at a lower level than the previous month, markets were expecting a pause this time as well. Inflation based on the Consumer Price Index (CPI) was at 9.87% for December compared with 11.16% in the previous month.
Says Indranil Pan, chief economist, Kotak Mahindra Bank Ltd -- "He (Raghuram Rajan, governor, RBI) could have done this (increase rates) in the December policy and could have left rates unchanged this time, which would have reduced the uncertainty in the system."
In the interim, however, another big development took place -- the Urjit Patel Committee report was submitted. The Committee has recommended that RBI should adopt the CPI as "the nominal anchor". It has also recommended bringing down the CPI inflation to 8% in the next 12 months and to 6% in the next 24 months.
However, the policy statement indicates that further tightening is not anticipated in the near term.
Deposit and lending rates
Will the hike in repo rate lead to higher deposit and lending rates? Analysts, economists and bankers don't expect lending or deposit rates to go up at this stage. Says Vishal Narnolia, analyst, SMC Global Securities Ltd: "Though the repo rate has been increased to 8%, banks may not be able to pass on the hike, at least to the corporate sector due to dwindling asset quality and lower credit demand. To keep their margins intact, banks may reduce retail deposit rates a notch, may be 10-15 bps, for below one-year fixed deposits."
Echoing the thought, Alpesh Mehta, banking analyst, Motilal Oswal Financial Services Ltd, says, "We doubt that the hike will be passed on to the customers, on both lending and deposit sides."
Economists say that other factors, too, will play a role. Says Dharmakirti Joshi, chief economist, Crisil Ltd: "This hike will not lead to an increase in lending rates immediately; it will all depend on the liquidity condition of the banks. As of now, will banks hike lending and deposit rates is an open question."
Growth, too, could be a deciding factor. Pan of Kotak Mahindra Bank says, "Immediately, this repo rate hike will not mean anything and will not be passed to the deposit or lending side. It will come with a lag of maybe 6-9 months, depending on the traction in growth, which is not very clear right now considering that we are in the election year."
Bankers are evaluating the decision, but they also feel that things may not change immediately. Says Abraham Chacko, executive director, Federal Bank Ltd: "Banks will be in a wait-and-watch mode. I doubt that it (rate hike) will have an impact on deposit and lending rates, unless there is demand in the credit offtake. It will depend on individual banks."
Stock market impact
The stock market fell sharply after the announcement but recovered later as it digested the news. Daljeet Kohli, head-research, IndiaNivesh Securities Pvt. Ltd, says, "It is not correct to think that we are out of the rate tightening cycle." He further argues that conditions are still uncertain and fundamentals are unlikely to change in the near term.
In terms of the impact of the policy and the fact that rates are unlikely to come down in the near term, rate-sensitive sectors may get affected. Dipen Sheth, head (institutional research), HDFC Securities Ltd, says, "The market will get skewed in favour of companies that are not leveraged. Things will be difficult for cyclical (sectors), and particularly for those companies that are highly leveraged."
Markets are also waiting for the outcome of the Federal Open Market Committee meeting of the US Federal Reserve scheduled for 28-29 January on bond buying.
Mint Money take
RBI is moving towards CPI as its nominal anchor and since that continues to remain close to the double-digit mark, there is practically no scope for cutting rates in the near term. On the contrary, if the US Federal Reserve decides to increase the momentum of tapering, there could be volatility in the currency market, which could push inflation up and also affect financial stability. This, in turn, could be a ground for RBI to increase rates in the future. However, if you are a borrower, Tuesday's rate hike is unlikely to increase your equated monthly instalments (EMIs) immediately. But if you plan to take a fresh loan, be careful, as this may not be the peak of interest rates cycle. If you are waiting for your EMIs to come down, your wait is likely to get longer.
From the stock markets point of view, it is advisable to stick with quality names and avoid leveraged companies for now. Investors would also do well to be selective among cyclical sectors such as banking and auto.