The credit policy announced on Tuesday has a few surprises, which however have not shocked the market as the 10-year bond yield has moved down post announcement to less than 7.5%. A rate hike was on the cards but the surprise was the rather heavy 50 bps hike in the repo rate. Also an upward revision in the inflation forecast came as the icing which is indicative of further rate hikes during the course of the year.
The impact of these rate hikes can be looked at from the point of view of different constituencies.
For loans which are linked to external benchmarks, there is a direct proportional increase in cost of credit. Hence, if a home loan is linked to the repo rate, which is so for several banks, then the EMIs will go up. Similarly, if SME loans are linked to the repo rate, cost escalation is immediate. However, if linked to the T-Bill or G-sec the transmission will be slower as market rates will rarely go up by the same quantum of repo rate hike.
Deposit holders will be better off for sure. With interest rates rising at the policy end, banks would also revise their deposit rates based on requirement of funding. Presently with there being surplus funds in the system and slow growth in credit, banks may not find it necessary to hike rates on deposits across the board and would invoke the same across specific maturities depending on their balance sheet position. The last rate hike did see some banks increase rates across some tenures and the same can be expected. But it would still be some time before deposit holders can expect positive real returns.
For larger companies, their cost will be linked with the MCLR. The MCLR is formula based and will increase by less than proportion to the repo rate hike. Hence, while costs will go up, it will be of a lower quantum. The better rated companies may still prefer to borrow from the debt market where the cost would get fixed more to the G-sec yields which are also expected to increase. Their decisions to borrow may not be affected if they see good demand emanating in the economy as interest cost averages around 3-4% of turnover for most sectors and can be absorbed quite easily provided business is good. However, for SMEs their operations would tend to be impacted.
The RBI has also assumed an oil price of $ 105/barrel which is much higher than the assumption in the Budget. This will give food for thought because while the OMCs have held back any further revision in price of petrol and diesel even as oil price has climbed back to $ 120/barrel, at some time the oil matrix needs to be addressed. The RBI has hinted that if states reduce their VAT on fuel products, inflation can be lowered further just like how the recent reduction in excise duties has helped to lower prices.
On the whole we may expect further increases in the repo rate as the RBI has high inflation forecasts for the first three quarters of above 6% in each segment. We may expect another 50-75 bps increase in repo rate though the sequencing of the same will be what the market will be guessing.
The author is Chief Economist, Bank of Baroda