Expert Views: RBI hikes repo rate, CRR remains unchanged

With the RBI raising the interest rate for banks, loans to purchase cars and houses are set to become costlier

September 21, 2013 1:09 IST | India Infoline News Service
The RBI (Reserve Bank of India) in its Mid-Quarter Review of Monetary Policy 2013-14 on Friday hiked the repo rate by 25 bps (basis points) to 7.5% and consequently the reverse repo rate stood at 6.5%. The central bank kept the CRR (cash reserve ratio) unchanged at 4%.

The repo rate is the rate at which banks borrow from RBI and one basis point is equivalent to 0.01%.

RBI Governor Raghuram Rajan, in his maiden policy review, reduced daily CRR requirement to 95% from 99% and maintained MSF (marginal standing facility) rate to 75 bps to 9.5%.

The rate hike, meant to control inflation, indicates that the RBI will continue to focus on price stability under Dr Rajan’s governorship.

Dr Rajan in his policy statement clearly indicated his views on interest rates, inflation and the Indian rupee. He believes that the interest rates are too low given the level of inflation in the economy. He is sure that the Fed will start tapering off bond purchases sooner than later and that the INR is not out of the woods yet.

The mid-quarter review of the monetary policy by the RBI has evoked a mixed response from the industry, which was hoping for a rate cut. The surprise rate hike and liquidity boost by governor Raghuram Rajan left analysts and economists divided with some appreciating the measures as "growth-supportive", while others saying he has left market confused and furthe hampered the growth.

Planning Commission Deputy Chairman Montek Singh Ahluwalia said that the RBI policy indicated a "balanced" approach to deal with high inflation and slacking growth.

According to Ahluwalia, Rajan has done something which will ease liquidity and reflect that RBI is concerned about bringing inflation down.

With the RBI raising the interest rate for banks, loans to purchase cars and houses are set to become costlier, a
ccording to some realty players.

On increase in the repo rate, Pankaj Bansal, Director, M3M India, pointed out that the cost of borrowing and owning home will become more costly. This will put the realty industry in a more difficult situation. In the last few days, banks have already started raising their rates and due to increase in the repo rate, banks may further increase the interest rates which will hurt both buyers as well as developers.

Echoing the same views, Shailesh Puranik, Managing Director, Puranik Builders Pvt Ltd, said, "We were expecting a reduction in the interest rates considering the current environment of economic uncertainties. The RBI seems to be focused on taming the inflation, but we are hopeful of some corrective measures by thenew RBI Governor soon.”

Speaking about the hike in interest rate, Cushman & Wakefield said, the realty sector would witness further slowdown. The sector is already plagued by retardation in sales, increasing input costs, liquidity issues and high costs of capital, etc. However, it is the government’s job to tackle these issues by implementing reforms that ensure speedy development of infrastructure necessary for growth of the markets.

Describing the policy as neutral in nature, Bikram Sen, CEO, Arthveda Fund Management Pvt Ltd, said, "The increase in repo rate was a surprise, but short term liquidity is expected to improve in future."

"With early signs of the rupee stabilizing and external pressures easing, the central bank has shifted focus to the growth-inflation dynamic and also restoring repo as the main policy rate. Notwithstanding the weak economic environment, the repo rate hike clearly reflects the central bank’s discomfort with inflation trends. The rate hike can also make the INR attractive for foreign investors from a more fundamental viewpoint,” Santosh Kamath, CIO-fixed income, Franklin Templeton Investments, India, said.

Noting that the reason for repo rate hike is pinned squarely on inflation, Kamath said that the monetary easing could follow as rupee stabilizes and the growth-inflation dynamic turns favorable. However, markets are likely to remain volatile in the near term, until policy clarity emerges. Corporate bond and short term bond focused strategies can help investors navigate through the uncertain environment. Investors with a relatively long investment horizon and comfortable with interim volatility can take exposure to long dated portfolios.

The repo rate hike has taken investors by surprise and bond yields have moved up. Short-term funding costs are likely to ease, as they are linked to the overnight rate, and the current inverted yield curve is likely to flatten, Mr Kamath further said.
Reduction in daily CRR balances would bring considerable relief to the short end of the yield curve and transmit to lower rates, HDFC Bank Research, said.

RBI reduced the MSF and hiked repo rate with the objective to normalise conduct and operations of monetary policy. Once supply side measures are in place and food inflation falls, the central bank will ease monetary policy to support growth but till that time policy will remain tight," Kunal Shah, fund manager-debt, Kotak Mahindra Old Mutual Life Insurance, added.

Delay in tapering by Federal Reserve made it possible for RBI to cut MSF rate. However since tapering is inevitable, RBI should continue to use short-term interest rate to stabilise rupee. Interest rates will remain high till inflation restarts its downward trajectory and currency stabilises, Shah elaborated.

The Governor has stuck to his mandate of managing the monetary risks which continue to be highly prone to inflationary and currency devaluation risks, Cushman & Wakefield said.

The Monetary policy announced is in tune with earlier policies, where true to the central bank’s role, the RBI has given priority to control inflation. Against the market expectations, RBI has increased the repo rate by 0.25% to tackle higher global crude prices and cost escalations due to rupee depreciation, Kuntal Sur, Director-India, KPMG, said.

Further easing out of policies will be on-going basis and the timing and direction of further actions will be contingent upon exchange market stability, and can be two-ways, Sur emphasised.

Commenting that RBI has an unexpected combination of measures in its policy review, Naresh Takkar, MD & CEO, ICRA, said that the central bank has commenced the easing of exceptional measures instituted since July 2013.

Terming the policy stance as strongly hawkish, Takkar said, "RBI has indicated that further actions could be two-way, contingent on exchange market stability. The magnitude of NRI inflows attracted over the next two months would be critical for the direction of future rate actions by the RBI in light of uncertainty regarding the timing of QE taper and its impact on future FII flows. 

Noting that high inflation
remains the priority of RBI, Srei Infrastructure Finance said that the industry will have to take the suffer the pain of this rate hike, especially the infrastructure sector which is quite stressed at the moment. The country needs huge investments in infrastructure and half of that is expected to come from the private sector. It is difficult to foresee how private sector will be able to mobilise resources from domestic sources in this scenario.

Commenting on policy measures to prevent rupee from depreciating further against the dollar,
PHD Chamber of Commerce and Industry (PHDCCI), President, Suman Jyoti Khaitan pointed out that hike in repo rate will adversely impact the consumption demand especially during the festive season. Starting from October to December, the festive season is considered to be an auspicious time to buy and there is an increased demand for almost all products ranging from electronic appliances to cars and houses.

Consumption is starting to weaken even in rural areas, with consumption of durable goods being hit the hardest.

The softening of monetary policy stance is one such step which is the need of the hour as it will lead to a phase of consolidation and stability in the sagging economy and pave way to resume growth.

Read more:
What is Marginal Standing Facility?
What is CRR, repo and reverse repo rate?

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