RBI surprised markets, experts, borrowers, depositors, and the industry among others by increasing the policy repo rate under the liquidity adjustment facility (LAF) by 40 basis points to 4.40% with immediate effect.
Further, the standing deposit facility (SDF) rate stands adjusted to 4.15%, and the marginal standing facility (MSF) rate and the Bank Rate are set at 4.65%.
Mounting inflation has been a cause of concern globally after the consistent rise in crude oil prices and the uncertainty over the Russia-Ukraine war. It was expected that RBI will be increasing repo rates going forward, however, not so soon. But RBI’s policy move is seen as inevitable ahead of the US Federal Reserves which is scheduled to announce its policy today as well.
Prasenjit Basu – Chief Economist, ICICI Securities said, “The persistence of high crude oil prices, and uncertainty over the length of the Russia-Ukraine war, have resulted in sustained inflationary pressure globally. With the Chinese and Japanese currencies depreciating 4% and 6% respectively last month, emerging market currencies are under pressure. Although the rupee has depreciated only 1.1% in the past month, any further downward pressure on the rupee would spark greater worries about imported inflation, so a timely rate hike was needed ahead of the inevitable US rate hike expected this week.”
Indranil Pan – Chief Economist, Yes Bank said, “The logical underpinning of RBI hike today and away from the regular policy date is the rising concern on inflation – especially with regards to food. Food inflation, more than non-food inflation, can change inflation expectations in India drastically. The governor pointed out that even as domestic supplies are healthy, global high wheat prices are affecting domestic prices while edible oil prices have increased due to the ban on exports from Indonesia. Manufacturers may also pass on higher input costs to end-users sooner than later. Thus, the crucial backing for the 40bps hike came from an understanding that inflation is here to stay. The timing of the hike is important too as it seems to just precede a likely 50-75bps increase in the policy rate by the US Fed. This is possibly to ensure that the INR is safe from any speculative attacks, notwithstanding the LIC IPO, and especially as the FX reserves are down by around US30 bn from their peak levels. In this financial year alone, India’s FX reserves are down by about $6.9 billion.”
Also, Shivam Bajaj, Founder & CEO at Avener Capital said, “The hike in the Repo Rate has been announced to mitigate the results of spiking inflation rates in the economy. As the RBI announces withdrawal of its accommodative stance, this move might hint at the RBIs willingness to further tighten the liquidity in the forthcoming time.”
But what does a rate hike mean on fixed deposits?
Any change in RBI’s policy repo rate will have an impact on the lending and deposit rates of the bank. However, the quantum and timing of passing on the policy repo changes depend upon the bank.
While the interest rates on term loans such as houses, cars, and personal among others – are seen to get higher during a rate hike. This is the opposite for deposits as they seem to become attractive with interest rates getting higher during rate hikes – giving hefty returns to depositors on their investments in traditional schemes, especially in fixed deposits which are less risker than compared to market instruments and also offer guaranteed returns.
Ajit Kabi, Banking Analyst at LKP Securities said, “RBI has raised the repo rate by 40bps with immediate effect and CRR by 50bps by 21st May 2022. The rate hike was much-anticipated factoring rise in food and general inflation. The rate hike is likely to shrink liquidity in the economy overall. As per as the banks are concerned the cost of funds is likely to increase so does the cost of deposits. It may translate into NIMs pressure. However, a quick increase in MCLR May controls the NIMs squeeze.”
As per RBI’s guidelines, the cost of deposits is directed to be calculated using the latest interest rate/card rate payable on current and savings deposits and the term deposits of various maturities.
Anjana Potti, Partner, J Sagar Associates (JSA) said, “The geopolitical situation caused by Russia’s invasion of Ukraine is weighing on all markets. Market watchers across the world have their eye on the US Federal Reserve which likely to announce a decision to increase rates later tonight. Central banks in many countries are raising rates to counter the effects of inflation. These costs of borrowing had fallen to record lows during the pandemic to bolster growth.”
Following this trend, the RBI has increased its repo rate from 4.00% to 4.40% and according to the JSA Partner this is likely to have a significant impact on the market including on:
1. Short-term deposits – short and mid-term rates always rise quickest in response to any change in the interest rate cycle.
2. Retail borrowing: Interest rates are likely to be higher for new borrowers. Existing borrowers with floating interest rates will also be affected.
Meanwhile, ICICI Securities’ chief economist says, “The whole structure of interest rates will harden, implying that loans will be costlier and fixed deposits more attractive. The equity markets will take a negative hit, especially since this was a surprise inter-meeting hike. We were expecting a hike at the next MPC meeting, after the hawkish hints at the last MPC meeting a month ago, but today’s move was larger and earlier than expected.”
In terms of credit growth, Ravi Subramanian, MD & CEO, Shriram Housing Finance said, “The rate hike today marks the end of the all-time low-interest-rate cycle, seen over the last two years. As such, several banks have been hiking benchmark lending rates tracking the rise in money market rates. Lending rates, however, are unlikely to surge immediately as financial institutions will look to support growth and credit demand in Q1 but borrowers need to take higher rates in FY23. Demand for home loans remains buoyant, especially in the affordable housing segment and the immediate impact of the rate hike should be minimal on credit growth.”
Going forward, Prasenjit Basu said, “If the Russia-Ukraine war persists beyond May and June, more rate hikes will be needed. If there is an early end to the war (within the next 5-6 weeks), global inflationary pressures will ease, reducing pressure for further rate hikes.”
That would mean that fixed deposits have not just gotten attractive with the latest 40 basis points hike in policy repo rate. But there is further room for more hikes which will likely lead to a rise in demand for FDs.
“The long-term impact of this rate hike across markets shall be an interesting sight,” Bajaj said.
Fixed deposits have been trending in India for decades. It is like a haven for investors who do not wish to bear risks and volatility on their money. They are not just friendly and one of the most preferred risk-free investments but also offer tax benefits in the long term.