The End

RBI has signalled the end of soft interest rates. This will impact capex and economic recovery.

The period of falling interest rates that almost started with swearing-in of the NDA government four years ago seems to be coming to an end. During this period, the repo rate, at which banks borrow from the Reserve Bank of India, or RBI, fell from around 8 per cent to 6 per cent. Now, with the RBI raising the rate by 25 basis points, there is a view that India is entering another rate increase cycle. But is it so?

There are enough reasons to believe that this is indeed the case. The RBI has projected consumer price index inflation of 4.85- 4.9 per cent in the first half and 4.7 per cent in the second half of 2018/19. This is above the RBI's target of 4 per cent (+ - 2 per cent). In fact, the RBI was this time way behind the curve as yields on 10-year benchmark government securities had been hardening for the past few months. The market, it seems, sensed the possibility of a rate increase well in advance due to rising crude oil prices and weakening rupee, both of which mean there is a high chance of inflation hardening. In addition, the US Federal Reserve, or US Fed, is already on a rate increase cycle. The unwinding of balance sheet (by selling securities) by the Fed will add further pressure on rates. In fact, RBI Governor Urjit Patel recently wrote in a global financial daily where he appealed to the US Fed to reduce the pace of balance sheet unwinding.

There are a number of indications of interest rates tightening. This will impact economic recovery, capital expenditure cycle and also the consumption story.