Analysts see further hikes, tighter liquidity; RBI keeps stance ‘neutral’, maintains growth, inflation outlook.
With the Reserve Bank of India (RBI) raising the repo rate by 25 basis points (bps) to 6.5% on Wednesday, bank lending rates are expected to stay firm or even inch up in the months ahead. This is the second hike in the key policy rate in 2018-19 after the 25 bps increase in June.
Loans rates have been going up for the past few months now as banks have looked to protect their margins; with deposits growing at a very modest pace banks have also needed to raise interest rates on deposits, especially for term deposits. State Bank of India’s (SBI) marginal cost of funds-based lending rate is now 8.25% while that for Punjab National Bank is 8.6%.
SBI managing director PK Gupta said there is a liquidity mismatch in the system with loans growing 12-13% year-on-year and deposits at a modest 8%. “With the busy season ahead, credit growth could rise to 14-15% and that would see liquidity becoming tighter. As such, banks would have to increase lending rates,” he said.
In fact, with economists anticipating further hikes in the repo rate and liquidity not expected to be abundant, lending rates could stay elevated for the next six to eight months, money market experts believe.
While the bond market saw a mild rally with the yield on the benchmark ending at 7.70%, 7 bps lower than Tuesday’s close, treasurers believe this was on account of the central bank’s assurance it would keep the liquidity situation neutral instead of letting it move into a deficit.
“We believe that another rate hike is still on the table and as a result bond yields could continue to go up after today’s relief rally,”said Abheek Barua chief economist, HDFC Bank. Barua pointed out that even without a major uptick in inflation, the sheer supply of bonds — borrowings by the states and the Centre — could keep yields elevated. “Only 20% of the budgeted borrowings for the Centre and state governments has been done with the majority of the supply expected to come in the second half of the year,” he said.
However, Sonal Varma, chief economist at Nomura, believes that having delivered a cumulative 50 bps of rate hikes already and with a real repo rate of ~1.7%, the RBI will leave the policy rate unchanged through FY19, giving it time to assess the impact of the hikes already delivered, and growth and inflation are expected to soften in coming quarters.
The central bank maintained its growth projections for 2018-19 at 7.4% while forecasting 7.5% for Q1 2019-20.
RBI governor Urjit Patel said at the post-policy press conference that the main reason for changing the policy rate is to ensure that, on a durable basis, “we come to and maintain our inflation target of 4%”. Patel said it was important not to drift away from the 4% target on a durable basis. India’s retail inflation jumped to a five-month high in June, with consumer prices rising 5% from a year earlier, compared with a 4.87% increase in May. June was the eighth straight month in which inflation was higher than the RBI’s medium-term target of 4%.
The RBI, however, maintained its neutral stance, reserving room for further monetary policy actions in accordance with the inflation data in the coming months. It also said that the impact of the two rate hikes in FY19 will be felt with a lag.
“Many of the risks that we have cited, and which form our projection, are on the both sides and that is why we have said that these projections are based on balanced risks. Secondly, there is a fair bit of uncertainty around the CPI prints going forward and, therefore, it was important that we kept our options open,” Patel said.
The RBI has largely maintained its inflation projection for the second half of FY19 at 4.8%, but has projected the consumer price inflation to be at 5% in the first quarter of the next fiscal.
Deputy governor Viral Acharya said the impact of the increase in the minimum support price, as announced by the government, is a challenge. It will not only have an impact on prices of food items, but also push up rural wages.
The RBI said it will continue to monitor the liquidity situation in the banking sector. The liquidity situation has been volatile in the last couple of months, with liquidity slipping into deficit in the second half of June due to advance tax outflows. Although it moved back into surplus in early July on the back of government spending, it has turned into a deficit in the second half of July.