‘Unkindest’ rise in interest rates

The sudden announcement by RBI Governor Shaktikanta Das that the central bank is raising the repo rate by 40 bps to 4.40% with immediate effect and the Cash Reserve Ratio (CRR) by 50 bps to 4.50% effective May 21, is a kneejerk reaction, and too steep a rise after maintaining status quo in interest rates for nearly two years -- that too unscheduled, thus validating those who consider it the ‘Reactionary Bank of India’.

The sudden increase in CRR, which virtually sucks out Rs 87,000 crore to Rs1 lakh crore of liquidity in the market, is bound to affect the nascent growth that we are seeing now, at least in the short run. CRR is the percentage of ‘cash’ as a proportion of bank deposits that are required to be parked with the RBI as a reserve and does not earn any interest rate!

Why now?

1. CPI inflation has for a long while now been above the 6% tolerance limit of the RBI – it was 6.01% in January, 6.07% in February, 6.95% in March, and is expected to hit 8% for April 2022. Since both CPI and WPI inflation are rising, the RBI has, to salvage its credibility, suddenly woken up to hike the rates to show that it can still take ‘independent’ decisions -- unscheduled. None of the local/global situations like high inflation rates, low credit offtake, spurt in crude oil prices beyond $105/barrel, spurt in commodity prices due to Russia-Ukraine war are any different today from the time of the last policy announcement.

2. Das’ rate hike came hours before the expected rate hike by the US Federal Reserve. The RBI has pre-empted the rate hike by the Fed to send palliative signals to Foreign Institutional Investors (FIIs, who are fair-weather friends) not to get jittery and to prevent flight of funds from India to the US or other countries for better returns.

3. The RBI has realised, rather late, that the rise in inflation is on account of supply-side ‘bottlenecks’, wherein the role of the government or prudent fiscal measures is more critical, such as reducing excise duties on petrol and diesel (which is not happening), increase in capital expenditure in growth-triggering sectors. Keeping interest rates at historic low levels will not yield any positive results but will adversely affect the bond yields and government borrowing.

4. The marginal increase in credit offtake by the banks has been mainly to ‘retail credit’ -- personal, credit cards, and vehicle loans, and not to core sectors like infrastructure, MSMEs, steel & cement, housing, which are the true engines of growth through the multiplier effect on investments, jobs, incomes and savings cycle. Such loans will lead to conspicuous consumption and eventually can turn out to be ‘bad loans’.

Impact

1. The RBI was behind the curve in raising the rates. The rate hike should have started two quarters earlier and in a calibrated manner. The 40 bps rise in repo rate signals the desperation and the need to prevent the exodus of FII funds.

2. The steep hike in the repo rate, which is normally the ‘benchmark’ rate for banks to decide on their lending rates for housing loans, MSMEs and infra/builder loans, will now witness an upward revision, thus making retail loans such as housing, personal, vehicle, credit card loans and builder loans costlier. The minimum lending rate will now shoot up to 8% and above and can even touch 10% for loans considered based on informal income/cash income profile. The quixotic increase by a whooping 40 bps will damage the credit offtake of banks, HFCs and NBFCs, thus affecting the nascent growth trajectory and green shoots that we witnessed in the last 2-3 months.

3. The rate of interest on corporate loans will now shoot up as such rates are not linked to external benchmarks but to the Marginal Cost of Lending Rates (MCLR) of banks, which will get costlier now.

4. Costlier loans will not only lead to poaching of loans by banks and HFCs which have interest differentials but will also lead to delinquencies/NPAs in the retail loan segment.

5. The only positive impact of the increase in CRR will be on the deposit rates. Since bank money gets locked up as CRR with RBI, banks will now aggressively mobilise for long-term deposits by offering attractive rates to garner funds for onward lending. This will also
avoid asset liability mismatch.

In sum, the unscheduled rate hike is too sudden, too steep and most ill-timed.

(The writer is a former banker)