Loans may get costlier, deposits attractive as RBI hikes rates

Home, auto and corporate loans are likely to become expensive, with the RBI on Thursday raising key short-term lending and borrowing rates by 0.25 and 0.50 percentage points, respectively, to combat inflation.

In its maiden mid-quarterly monetary policy review, the central bank upped repo, under which it lends short-term funds to banks, to six percent and reverse repo, the short-term borrowing mechanism, to five percent.

The hike in the policy rates, the fifth this year, to cool inflation that is hovering at 8.5 percent may lead to an increase in commercial lending and deposit rates.

"In early October, interest rates could be revised and chances are there it could be revised upwards," state-run Bank of Baroda's Executive Director R K Bakshi said.

Bankers said they will hold on to the rates till September 30, which is the half yearly closing of the banks.

High interest rates could temper demand for loans and thus curtail consumption, while on the other hand fixed deposits could earn better returns.

The government expects inflation to cool to six percent by December.

"Rate of interest may have to go up. Pressure is there to increase rates in the near term," Bank of Maharashtra CMD Allen Pereira said.

Short-term funds would get little costlier and there is possibility that the short-term (deposit) rates could also go up in the future, bankers said.

Central Bank of India CMD S Sridhar said, "Bankers will adopt a calibrated approach. The examination of interest rates is on cards as cost of funds for banks is increasing."

However, a few bankers ruled out increase from October 1 as they will wait for further policy action of RBI.
"EMIs are not going to go up from October 1. The quarter percentage increase in policy rates were expected. Further rate hikes by bank will depend on the next policy review," HDFC Chief Executive Keki Mistry said.

He said a further increase in rate in the second quarter review in November could lead to higher rates.

Following an identical hike in repo and reverse repo rates in July, 40 banks raised deposit rates and 29 lending rates.

The RBI too wants deposit rates to go up as there is a need to make the real interest rates, the difference between inflation and deposit rate, positive. "...real interest rates need to move in the direction of encouraging bank deposits", the central bank said.

Industry chamber FICCI also expressed the fear that rising interest rates would hit business.

"Increasing repo rate is another signal of rising the cost of borrowing...hopefully it is the last such...restrictive action towards growth. We hope to see this restrictive policy eased in the next round", said FICCI secretary general Amit Mitra.

Expressing concern over the RBI move, PHD Chamber said, "This will adversely impact the cost of borrowing by the industry from the banks, especially by the SMEs. It may also the cost of home loan as well as consumer loans."

For RBI the major concern in inflation as "headline inflation remains significantly above the trend of 5.0-5.5 percent in the 2000s.

"I think it (the RBI move) is in the right direction because now the corridor (difference between repo and reverse repo) has been narrowed down and still inflationary pressure is there in the system," Finance Minister Pranab Mukherjee told reporters here.

The 100 basis points gap between repo and reverse repo marks the return to the pre global financial meltdown level.

Planning Commission Deputy Chairman Montek Singh Ahluwalia said: "This (hike) is in the right direction and on the expected lines. This is not going to affect the economic growth."

Government data last month showed that the economy grew by an impressive 8.8 percent in the April-June quarter, driven by a robust manufacturing sector.

However, the central bank wondered if the industrial expansion data was reflecting the reality.

"Although the year-on-year growth rate for the first four months of the year remains robust at 11.4 per cent, the high volatility over the past two months raises some doubts about how effectively the index reflects the underlying momentum in the industrial sector," RBI said.

The data on the Index of Industrial Production (IIP) showed that industrial growth accelerated to 13.8 per cent in July from 7.2 per cent a year ago, belying all expectations of slowdown.

RBI described the data as volatile since the previous month it was just 7.1 percent, which was further revised down to 5.6 percent, analysts said.

The comments by RBI also assume importance, since the Government itself committed a blunder while computing GDP data from the demand side, and revised it by around three times, a day after.

RBI may raise key rates tomorrow to tame inflation: Experts

RBI is likely to raise policy rates by up to 25 basis points in its mid quarterly policy review Thursday to tame inflation, which is still ruling near the double-digit mark, said experts.

Inflation, as per the revised index was 8.51 percent in August, although it was 9.5 percent according to the old index.

Even finance minister Pranab Mukherjee, while responding to decline in inflation, which under the new series fell by 1.3 percentage points during August, had said, "there is no room for complacency... we must continue to be vigilant and be prepared with the instruments of fiscal and monetary policy to use them as and when the need arises."

Citigroup said in its research report said, "given trends in both macro and sectoral data, coupled with the RBI saying that policy rates are still far from a normal position, we expect the RBI to raise both repo and reverse-repo rates by 25 bps in its review on September 16."

The government, Tuesday, came out with a new wholesale price index series that measured inflation in August at 8.5 percent based on 2004-05 prices.

Although the August figure is lower than that of July which was at 9.8 percent, experts believe the supply and demand side pressures still remain and RBI should hike its short-term lending (repo) and borrowing (reverse-repo) rate to control money flow.

RBI deputy governor Subir Gokarn also expressed concern, saying "the inflation rates that the economy is now experiencing, both from the supply and the demand sides, are clearly a matter of great concern. It is incumbent on the government and the central bank to use all the means at their disposal to rein inflation."

This is the first time that the Reserve Bank is coming out with a mid-quarter economic policy review.

"The RBI will go in for a rate hike as robust growth in industrial output and healthy economic growth would give the RBI enough cushion to make money expensive," Deloitte Principal Economist Shanto Ghosh said.

The RBI has raised interest rates four times this year, upping key policy rates by 100 basis points as it tries to combat high inflation in Asia's third-largest economy.

In its first quarter monetary review in July, the central bank had raised short-term lending and borrowing rates by 0.25 percent and 0.50 percent, respectively.

Following the increase, the repo rate stands at 5.75 percent and the reverse repo rate at 4.50 percent.

India's GDP grew by 8.8 percent in the first quarter, against 6 percent in the April-June period last fiscal.

Furthermore, industrial output expanded by 13.8 percent in July from 7.2 percent in the corresponding month last year.

Inflation in August at 8.5%; FM says no room for complacency

The government Tuesday claimed a 1.37 percentage point dip in the politically sensitive inflation, as a new series measured it at 8.5 percent in August, but the Finance Minister said there was no room for complacency.

Although the drop is substantial, when measured using the old series, inflation during the month under review works out to 9.5 percent, down from 10 per cent in July.

"Even though the good news of lower inflation is reported today, yet there is no room for complacency... (government) will continue to bring it down further," Finance Minister Pranab Mukherjee said in a statement.

Prime Minister Manmohan Singh had earlier this year said he expects inflation to drop to 6 percent by December.

Mukherjee indicated Tuesday that the RBI could take some action in its mid-quarter review of monetary policy on September 16.

"Some international commodity prices have shown some recent inflationary tendency, especially the wheat prices worldwide... (which) have risen sharply following production shortfall in Russia and Ukraine," he said.

The fall in August inflation, however, came on the back of lower prices of food items like vegetables, cereals and pulses and sugar.

Mukherjee further said that "we must continue to be vigilant and be prepared with the instruments of fiscal and monetary policy to use them as and when the need arises."

Releasing the new series, Commerce and Industry Minister Anand Sharma said, "We hope that it (inflation) will come down. There are various steps taken by the government. Food inflation has been a cause of concern."

The new inflation series with 2004-05 as the base year has 241 more items than the old series with 1993-94 as the base year, which only reflected the price rise in 435 articles.

Edibles and non-edible items widely used by the middle class, like ice-cream, mineral water, microwave ovens, washing machines, gold and silver are reflected in the new WPI inflation series.

According to analysts, overall inflation, which is still close to 9 percent, may prompt the RBI to increase key policy rates by 25 basis points during its review later this week.

Deloitte Principal economist Shanto Ghosh said, "In an absolute sense, inflation is high. Unless there is significant softening in prices across the board, it will be a tough challenge for the government to meet the 5.5 percent inflation target."