Borrowers under pressure

BT Edition: December 2013

RBI reduced the marginal standing facility, or MSF, rate, at which it lends emergency funds to banks, by an identical margin. This rate cut is putting downward pressure on short-term rates.

 Borrowers face the heat as short-term rates under pressure

In its second quarter monetary policy released October 29, the Reserve Bank of India, or RBI, increased the repo rate, at which it lends to banks, by 25 basis points or bps. Simultaneously, it reduced the marginal standing facility, or MSF, rate, at which it lends emergency funds to banks, by an identical margin. This rate cut is putting downward pressure on short-term rates.

What it means for you: These moves will lower rates for short-term deposits. But long-term rates, especially on loans, are likely to rise.

After the announcement, HDFC Bank was the first to increase its minimum lending rate, called the base rate, by 20 bps to 10%. It also reduced rates for short-term deposits of 46 days to 6 months.

The next was India's largest bank, State Bank of India or SBI. The bank revised the rate for deposits of 180-210 days maturity by 20 bps. It also increased the lending rate by 20 bps. This increase means their minimum lending rates are now on a par with ICICI Bank's and Kotak Mahindra Bank's 10%, and higher than Canara Bank's 9.95%.

Will RBI increase rates further? The consensus view is that the RBI could increase the repo rate by another 25 bps by the end of the financial year, but this is not imminent in the December monetary policy.

Dr Shubhada Rao, Chief Economist, YES Bank, says: "Inflation is rising due to perishable commodities. Due to the effect of seasonality and expectation of good kharif output, the inflation in perishables should come down.

Therefore, a higher probability is that the RBI may decide to follow a wait-and-watch policy in December and raise the rate in the fourth quarter by 25 bps." Lakshmi Iyer, CIO, debt & head of products, Kotak Mutual Fund, points out that November inflation data will be released before the policy announcement.

Hence, it would be premature to conclude the outcome. "However, markets are already pricing in the possibility of another 25 bps rate hike in December," she says.

Rajesh Cheruvu, CIO, RBS Private Banking, who is expecting another 25 bps increase, however, says, "This could be the last hike for now." "The recent improvement in outlook for currency and crude oil prices combined with higher agriculture output is likely to stabilise inflation and avert further hikes," he explains.

Will banks also raise interest rates?"That possibility is very remote as of now. We will have to see how the RBI handles the liquidity crunch that the banks are facing," says Rao of Yes Bank.

To ease the liquidity crunch in the market, the RBI had conducted open market operations in November. This will give banks a breather. "If the condition worsens, it is possible that banks may end up increasing both lending and deposit rates," says Rao.

"If we see continued hike in repos rates, then banks would look at adjusting their lending rates upward. However, given that we are not seeing significant pick up on loan growth front, it will be difficult to do so if there is status quo on rates," says Iyer.