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Economy

RBI Raises Rates by 0.25%

As widely expected, the Reserve Bank of India has raised rates by 0.25% – of both the Repo and Reverse Repo, to 5% and 3.5% respectively.

Note however that there has been almost no demand for repo in the last year – in fact, just today there was one request for 400 cr. which must have made the day for the guy who records repo transactions because he’s been on a chai break for an entire year and he’s sick of chai by now.

Reverse repo, which is where banks park money with the RBI, was seeing volumes of 80,000 cr. + daily; today, we’ve seen just 5,430 cr. This entire week, volumes were thin – have banks started deploying that cash appropriately? Huge signs for growth, but horrendous for an already out of control inflation number.

RBI doesn’t change it’s stance just one time – typical rate raising cycles last a couple years. Expect rates to go up. This time there are a number of reasons for sustained increase:

  • Taming inflation through interest rates is a tough ask in India, where the transmission of interest rates to real economy is slow and weak. Still, it’s a signal for tightening and the only way people can say they are “doing something”.
  • RBI needs to borrow like crazy in the coming year to keep the government coffers available. The entire last year, we have seen very little in terms of tax collection growth, and expenses are going to remain high – borrowing, therefore, is likely to continue. High borrowing means more supply than demand, which means the government will pay higher rates to sell the bonds; higher government bond yields will push interest rates upwards.
  • Last year RBI had the option of taking money from the reserve created by issuing Market Stabilization Scheme (MSS) Bonds – called “de-sequestering” – and using it instead to fund the government. There’s only 5,000 cr. left in MSS, which nowadays is enough to cover only one MP’s telephone bill. (I’m kidding. With falling call rates we can accomodate two.)
  • With other countries worldwide having piled on way too much debt the interest rate raising cycle will continue abroad, and RBI will have to follow because they respect the ancient notion of money exiting to find the highest rate of interest. (Note: with our capital restrictions, and the fact that our dollar denominated debt is microscopic, that is unlikely to have a significant impact)

Okay – market impact. Banks will instantly raise their lending rates and PLRs and all that jazz, so expect a higher mortgage bill or EMI. For those locked into “teaser” rates, read your documentation carefully – I’ve seen some recently that allow banks to raise rates midway if it affects, among other things, their golf swing. What happens now is that banks offering teaser loans will have to deal with a smaller (but still pretty darn wide) spread between what they can borrow and what they’ve lent.

Real estate is going to have a tough time; sales aren’t happening, and if banks raise rates, hopes turn into prayers. No wonder nearly all RE stocks fell today.

Interest rate sensitives like Auto and the hugely-in-debt power sector will likely see some damage too, but only after more rate hikes.

What is good for savers is that deposit rates will increase.

  • Anonymous says:

    >Dear Deepak,
    In the reasons listed for sustained incraese in interest rates , in reason no. 2 u mentioned "high borrowing means more supply than demand ".Can you elaborate a little more on this to enable an interested reader like me to understand.Apologies in advance, if I am asking too much..
    Ajith