Impact of the RBI’s Repo rate Hike and beyond

As expected, the RBI announced a repo rate hike in its third bimonthly policy meet of 2018-19, on August 1, 2018. The repo rate now stands at 6.5%. After being reduced consistently since 2015, the central bank has raised the rate in two consecutive bi-monthly policies, by 25 basis points each time.

Why this action?

The main aim of the rate hike was to ensure that inflation, as measured by the CIP, remained within the medium-term target of 4%. For a variety of reasons, inflation impulses are growing; these include a pick-up in global economic activity, political tensions due to trade wars and the Brexit negotiations, a rise in oil prices, concerns about the roll-back of the easy money policy that has governed global financial markets for years now, and, nearer home, the hike in Minimum Support Price to farmers, etc. Against this backdrop, the RBI saw it fit to raise the repo rate to pre-empt any sharp rise in domestic inflation.

Impact beyond inflation…

At a micro level: The 50 basis point rise in repo rates, in two tranches, will be transmitted to banks over the next few months. When this happens, banks will raise both their deposit and lending rates, by around 50 basis points too. While that’s good for depositors, borrowers will face a higher cost of loans. Those with existing floating rate loans will see their EMI or loan term increase as well.

At a macro level: The rate hikes could have some impact on the investment cycle, as it will make loans more costly. However, it is unlikely to impact overall economic growth yet, as the growth momentum and public spending is strong at present.

Looking ahead

 With higher rates, does it make sense to postpone borrowing? Perhaps not. The RBI seems determined to adhere to its inflation target and has declared a neutral stand on monetary policy. Put together, what this means it that the RBI will not hesitate to increase interest rates further if economic circumstances indicate that prices will rise. And as things stand, most or all of the factors that have triggered the current rate hike seem likely to stay put in the near future. So, effectively, if the RBI does not raise rates in the coming months, it is unlikely to reduce them in a hurry either. As a result, waiting for rates to come down again may be a futile exercise.