What RBI policy means for banks, markets, deposit holders: Key takeaways: Business Standard !st August 2018

The risks pointed out by the RBI still remains the same with the MSP, oil price, demand, HRA factors driving the decision to hike rates

The RBI policy decision does come as a surprise given that the overall inflation projections have not really changed significantly for the year being put at 4.6% in Q2 and 4.8% in H2. There is an adjunct of a neutral stance which probably may not read deeply as a similar stance in the past has not precluded a rate hike in subsequent policies. Yet the call to hike rates should sound good for the savers while industry would have to be prepared to pay more on loans. Moreover, the days of easy money are probably over.

The risks pointed out by the RBI still remains the same with the MSP, oil price, demand, HRA factors driving the decision to hike rates. The impact of GST changes on soothing inflation has been pointed out which should mitigate the pressures and ensure that inflation remains less than 5%. The call on MSP is however debatable because even though MSPs have increased sharply this time anecdotally it has been seen that the same does not get translated into higher inflation for all crops. It normally works only when there is procurement or else the price movement is driven more by supply conditions. Therefore, the key would be the kharif crop and its impact on prices eventually taking into consideration both the MSP hikes and the supply of commodities.

The RBI appears to be very keen to ensure that the inflation number should remain at less than 5% during the year and hence the rate hike can be viewed more as a preemptory measure to quell any demand-side forces which could emanate given that core inflation has been the main driver of this number in the last 6 months or so. Future action should be data-driven and hence the monthly numbers on CPI inflation-especially the core inflation number becomes even more important.

What would this mean for the markets? First, banks will have to revise their interest rates which will be more sluggish than the markets. Deposit holders should gain and it may be expected that the MCLRs also react in a similar manner. Second, the market rates should increase soon and hence bonds should get more expensive. Third, government security yields will move upwards which is going to be problematic for banks when they mark to market their portfolios. They are still facing the twin challenges of NPAs and marking to market their investment portfolio. Given that they have excess SLR of above 8% NDTL< the amount is significant.

Fourth, this should be good for the forex market as the FPI flows could now turn positive with two successive rate hikes and the rupee could get more stable. Fifth, an increasing rate scenario at this point of growth in the country would make investing more expensive and given that global rates are also higher would mean that much more strain on corporate P & L.

Last, the economy has to be prepared now for a higher range of interest rates and the years of cheap money are over.