Inflation has been one of the biggest challenges before the Reserve Bank of India (RBI) for the past some time now. In its annual policy statement for 2011-12, most analysts expected the RBI to continue with its 'baby steps' and increase its key policy rates by 25 basis points (bps) as it had done on eight occasions since October 2009. Most of them were in for a surprise when the RBI hiked the rates by 50 bps.
The central bank wants to make money dearer to check rising prices. One bps is one-hundredth of a percentage point. With this policy, the RBI has adopted a single policy rate regime. Till now, the RBI had been operating through repo rate for lending money to banks and reverse repo rate for borrowing from them, both of which used to be set independently. Now on, repo will be the policy rate and reverse repo will be benchmarked to it, always 100 bps lower.
Though the rate hike will pinch your pocket, the RBI's decision to increase interest rate on savings bank deposits from 3.5% to 4% should come as a relief. The savings bank deposit rate, which is the only regulated deposit interest rate, had remained at 3.5% per annum since March 1, 2003.
The RBI has issued a discussion paper seeking public opinion on deregulation of savings account interest rate so that depositors can get interest rate in accordance with the prevalent market situation. Most bankers are not in favour of the deregulation as fierce competition among banks for increasing their proportion of low-cost current account and savings account (Casa) funds is expected to push interest rates on savings accounts.
According to an analysis by the central bank, the real savings deposit rate was persistently negative between December 2004 and December 2010, except during March-September 2009 when inflation had turned negative.
The Wholesale Price Indexbased inflation has gone up from below 2% in August-September last year to the levels of 9% today. The RBI's deviation from 'baby steps' can be attributed to the continuous rise in inflation.
"Earlier, the world economic environment was jittery and the primary focus was to support growth, which was the main reason that the RBI increased policy rates by 25 bps every time to ensure price stability," says Ritesh Jain, head, investments, Canara Robeco Mutual Fund.
"With domestic economy showing signs of resilience and sustainable growth, it was the need of the hour that the RBI approached inflation more aggressively." Most banks have responded to the move by increasing their lending and deposit rates.
"Banks are not in a mood to bear the burden and most of them have hiked their base rates by 50 bps," says I.C. Agasti, chief general manager, IDBI Bank. IDBI Bank has raised it base rate by 50 bps to 10%, while the public sector behemoth, State Bank of India (SBI), increased its base rate from 8.5% to 9.25%.
Depositors can expect hike in short-term deposit rates. SBI has already increased the rate on its short-term deposits (7-14 days) from 4% to 6.25%. IDBI Bank also increased its term deposit rates by 25-50 bps.
Higher funding costs for banks is expected to hit their margins. "Provisioning norms for banks have also been raised due to which banks will have to set aside more money for non-performing assets. It will ultimately hit their profits," says Agasti.
"Going forward, with stubborn inflation, high commodity prices and fiscal deficit concerns, the RBI could raise rates by additional 75-100 bps during the current fiscal," says Jain. The 10-year benchmark yield has moved up to its multi-year high of 8.3% after the recent policy announcement.
"It is likely to stay at 8.10-8.30% for a couple of months before gradually moving towards 8.50%. If you want to invest in debt funds, look at short-term income funds for the time being. Long-term funds should be looked at only after there are visible signs of inflation peaking out," adds Jain.