Home-, auto- and other loan EMIs are likely to increase after the Reserve Bank of India (RBI) hiked its key interest rate by 40 bps in a surprise move on May 4 in an effort to tame inflation that has remained stubbornly above target in recent months.
The increase in repo rate — the rate at which RBI lends to commercial banks — to 4.40% from a record low of 4% is the first since August 2018 as well as the first instance of the RBI governor-headed monetary policy committee (MPC) holding an unscheduled meeting for raising interest rates.
The RBI also hike the cash reserve ratio (CRR) by 50 basis points to 4.5%, which will now require banks to park more money with the Central bank and leave them with less to loan to consumers. This would drain ₹87,000 crore of liquidity from the banking system, RBI governor Shaktikanta Das said in a video address announcing the rate hike decision.
He, however, did not mention anything about the reverse repo rate and hence it remains the same at 3.35%. The standing deposit facility rate is now at 4.15% while the marginal standing facility rate and bank rate stand at 4.65%.
The MPC retained its accommodative monetary policy stance — meaning it can cut interest rates to support growth — at a time when globally inflation is rising alarmingly.
Persistent inflation pressures are becoming more acute, particularly on food, Mr. Das said, adding that there is a risk if prices stay at this level for "too long" and expectations become unanchored. "Inflation must be tamed in order to keep the Indian economy resolute on its course to sustained and inclusive growth," he said.
Increases in fuel and food prices, exacerbated by the war in Ukraine and sustained pandemic-related supply chain disruptions, have been above the RBI comfort zone of 2-6% for three months in a row. Headline inflation in March rose to a 17-month high of 6.95% and it may be above the target band in April too.
The MPC is scheduled to meet on June 8 and analysts expect it to again raise the repo rate by at least 25 bps. "The MPC judged that the inflation outlook warrants an appropriate and timely response through resolute and calibrated steps to ensure that second-round effects of supply-side shocks on the economy are contained and long-term inflation expectations are kept firmly anchored," Mr. Das said.
The governor, however, added that the monetary stance remains accommodative and actions will remain calibrated. "In the MPC's view, monetary policy response at this juncture would help to preserve macro-financial stability amidst increasing volatility in financial markets," he added.
The move surprised markets, pushing Benchmark Sensex down by 1,474 points in the intra-day trade and sending the yield on India's benchmark 10-year bond to 7.38%. One basis point is one-hundredth of a percentage point.
Deloitte India economist Rumki Majumdar said the rate hike was expected in June. “The surprise move by the RBI to raise the policy rates a month earlier suggests that it does not want to wait and watch but act quickly before inflation derails the growth recovery. However, making it costlier to borrow will affect consumers and businesses (especially MSMEs) and impact credit growth, which has been low since 2019. Economic activity will also likely see some restrain.” As the economy normalises, there is a rising concern about demand growing at a pace faster than supply, thereby, leading to demand-pull inflation. Besides, global inflation is also a concern. High commodity, edible oil, metal, and fertilizer prices due to the Russia-Ukraine crisis are adding to production costs. Both cost-push and demand-pull inflation drivers have been indicating that the RBI will have to act on price pressure worries.
The Central bank had reaffirmed its accommodative stance in February — a step criticised by some economists as too benign on the risk of rising prices. The RBI last month said that it would begin prioritising inflation over supporting growth.
"This is precisely in line with the stance of withdrawal of accommodation", which was announced at the last MPC meeting in April, Mr. Das said. The RBI has cut the repo rate by 250 basis points since February 2019 to help revive the growth momentum. The Monetary Policy Committee has been on a prolonged accommodative stance to support growth.
In its response to the pandemic, monetary policy had shifted gears to an ultra-accommodative mode, with a 75 bps reduction in the policy repo rate on March 27, 2020, followed by another reduction of 40 bps on May 22, 2020.
In April, it raised its inflation forecast to 5.7% for the current fiscal (2022-23), up from 4.5% and said it sees gross domestic product (GDP) growth during the year at 7.2% compared to a previous expectation of 7.8%. From October 1, 2019, all banks were mandated to lend only at an interest rate linked to an external benchmark, such as the RBI's report rate or Treasury bills yield. As a result, monetary policy transmission by banks has gained traction.
For two years, the RBI kept interest rates at a record low to support the economy. The six-member MPC had last held an off-policy cycle meeting on May 22, 2020, to perk up demand by cutting the repo rate by 40 basis points to a historic low of 4% in wake of uncertainty surrounding the COVID-19 pandemic.
The rate hike comes after 11 consecutive times, the last being just a month back, of the RBI holding interest rate at a record low of 4%
Investor wealth tumbles ₹6.27 lakh crore
Investors became poorer by more than ₹6.27 lakh crore on May 4 as markets crashed after the Reserve Bank of India (RBI) hiked the policy rate by 40 bps in a surprise move.
The 30-share BSE benchmark Sensex tumbled 1,306.96 points or 2.29% to settle at 55,669.03. During the day, it plummeted 1,474.39 points or 2.58% to 55,501.60. In tandem with the slump in equities, the market capitalisation of BSE-listed firms tumbled ₹6,27,359.72 crore to stand at ₹2,59,60,852.44 crore.
"RBI surprised the markets with a 40 bps hike in repo rate and a 50 bps CRR hike, in an off-cycle meet by the MPC on Wednesday. The markets have obviously been taken by surprise," said Unmesh Kulkarni, Managing Director Senior Advisor, Julius Baer India.
Shrikant Chouhan, Head of Equity Research (Retail), Kotak Securities Limited, said, "Ahead of the Fed meeting in the U.S., the Reserve Bank has created a stir in the Indian markets by suddenly increasing interest rates. Behind this, we saw a sudden drop in the benchmark indices." Bajaj Finance, Bajaj Finserv, Titan, IndusInd Bank, HDFC Bank, Dr. Reddy's and Maruti were the prominent laggards from the Sensex pack.
In contrast, PowerGrid, NTPC and Kotak Mahindra Bank closed in the green. In the broader market, the BSE midcap gauge tumbled 2.63% and smallcap index declined 2.11%.
Among sectoral indices, BSE consumer durables fell the most by 3.88%, followed by realty (3.31%), consumer discretionary goods & services (3.01%), healthcare (2.92%) and telecom (2.73%).
