EMIs to rise as RBI hikes key rate by 40 bps after 4 years

MUMBAI: In a surprise move, the Reserve Bank of India (RBI) on Wednesday announced an increase in key interest rates by 40 basis points, the first increase since August 2018 and the sharpest in nearly 11 years, as it shifted gears to tame surging prices.

Rising prices against the backdrop of the war in Ukraine and breakdown of supply chains have emerged as a key policy challenge, prompting central banks around the world to raise interest and tackle soaring prices. Hardening of both retail and wholesale inflation above the central bank’s tolerance level has prompted the RBI to go in for a sudden rate hike aimed at protecting the growth recovery under way and shield consumers from the impact of surging prices of fuel and food.

Home loans and other retail loans as well as those availed of by businesses will get more expensive as around 40% bank credit is linked to the repo rate, which is what banks earn on the overnight funds that they park with the RBI. The MPC also increased the cash reserve ratio (the share of deposits that banks keep with RBI) by 50 basis points to 4.5% to suck out some cash from the system.

The repo rate has been revised to 4.4%. A 40-basis-point increase (100 basis points equal one percentage point) in key policy rates will raise the EMI on a Rs 1-crore home loan of a 15-year tenure by Rs 2,176.

“Globally, inflation is rising alarmingly and spreading fast. Geopolitical tensions are ratcheting up inflation to their highest levels in the last 3 to 4 decades in major economies while moderating external demand. Global crude oil prices are ruling above $100 per barrel and remain volatile.

Global food prices touched a new record in March and have firmed up even further since then. Inflation-sensitive items relevant to India, such as edible oils, are facing shortages due to the conflict in Europe and export bans by key producers.

The jump in fertiliser prices and other input costs has a direct impact on food prices in India,” RBI governor Shaktikanta Das said in his statement while explaining the rationale behind raising rates.

The RBI’s announcement came barely hours before the US Federal Reserve was set to raise rates by 50 basis points, the first such hike since 2000. The Indian central bank’s move surprised the market as the monetary policy committee headed by RBI governor decided not to wait for the next meeting until June and advanced the announcement. Besides, the quantum of the increase was higher than the anticipated rise of 25 basis points.

The decision sent the stock market crashing with the BSE sensex closing 1307 points lower. Between the time Das’s statement started and market closed, the bellwether index crashed 900 points. The rate hike is, however, seen as a positive for the rupee, which gained 24 paise to close at 76.42 against the dollar on Wednesday. Higher rates make Indian debt more attractive to foreign investors.

Wednesday’s hike reverses RBI’s off-cycle 40-basis-point cut announced in the wake of the pandemic in May 2020. Bankers expect the RBI to raise rates by 100 basis points this year, which leaves room for an additional 60 basis points. Following the announcement, other lending facilities, including the standing deposit facility and marginal standing facility, which are linked to the repo rate, will also rise.

All home loans, which are linked to the repo rate, will become costlier by 40 basis points. Some of the older loans are linked to the marginal cost of lending rates, which are already going up. The rate hike comes when bank credit is picking up, and banks are therefore likely to increase their term deposit rates to meet this growing demand.

The increase in interest rates will also reduce the net asset value of mutual fund schemes that invest in long-term debt. “In the case of older loans linked to MCLR, the asset-liability management committee would take the decision. Also, the pass-through would not be full as the MCLR is linked to the incremental cost of funds,” said A S Rajeev, MD, Bank of Maharashtra.

He added that with credit demand picking up, banks would also increase deposit rates soon, but the increase may not happen to the same extent as the repo rate. According to Rajeev, he does not expect the increase in the rates to impact the rising credit demand. While equity markets always react negatively to interest rate hikes as they are seen to be growth-inhibiting, the RBI said that the rate hike would be growth positive as it would protect savings, investment, competitiveness and output growth.

After the sharp rate cuts during the pandemic, home loans had fallen to 6.4% but lenders now say that sub-7% rates would be difficult to sustain. However, even if the home loan rates rose by 40 basis points, they would still be close to their historic lows. The increase in the CRR would not impact the surplus liquidity as there is over Rs 2 lakh crore of unused funds that banks park with the RBI. The rate hike pushed up yields on the benchmark 10-year bond to close to 7.4%, but bankers said that this was a knee jerk reaction and it would slide back to 7.3%.