Articles

• The RBI move:

  The media was abuzz with reports before the monetary policy. Some indicated the RBI would not and should not hike interest rates; some others forecast otherwise. The RBI, nonetheless, announced a 0.25 percentage point or 25 basis points (bps) rise in its benchmark lending rate—the repo rate. This is the rate at which the RBI lends money to the banks. It also happens to be the minimum interest rate for your retail loans from a bank. Meaning, if the RBI hikes its repo rates, your loans could turn costlier.

• The change in stance:

  As said earlier, this is the first increase in interest rates from January 2014. This usually suggests that the RBI has changed its stance from ‘neutral’ or ‘dovish’ to ‘hawkish’. The surprising part, however, is that the RBI clearly mentions that it maintains a ‘neutral’ stance. This gives the RBI the flexibility to move the repo rate in either direction to keep inflation on target. (In the past, we’ve explained a ‘Dovish’ monetary policy. Click here to understand.

• Why RBI hiked repo rate:

  The RBI has one big target—keep inflation under control. A lot of its monetary policy decisions get affected by inflation. This time too, the source of the repo rate hike can be traced back to a rise in inflation. Recently, an unexpected 12% rise in the cost of Crude Oil led to higher inflationary pressure. In fact, it was one of the red flags indicated by the RBI in its last policy. Even if you take out fuel and food from the measurements, retail inflation (measured by CPI) rose sharply in April by 0.8 percentage points (80 bps) from March. “[This suggests] a hardening of underlying inflationary pressures,” the RBI said in its credit policy review.

• Inflationary concerns

  Not just current inflation, but even the near-term forecast for rising prices matters to the RBI. Had it expected the current rise in prices to be a one-time blip, it may not have hiked rates. However, the central bank expects inflationary pressures to continue in the near term. This is because of multiple reasons as below:
  
        a) Continuation of high crude oil prices
  
        b) Uncertainty due to global financial market developments
  
        c) Significant rise in households’ inflation expectations that could lead to higher wages and input costs
  
        d) Potential impact by the revisions in House Rent Allowance (HRA) by state governments
  
        e) Uncertain impact of the revision in the formula to calculate the Minimum Selling Price (MSP) for Kharif crops
  

• The good-bad news

  There’s a silver lining in this whole picture. This lies in the RBI’s expectations for a strong, better economy. In fact, a hike at this time could potentially indicate the RBI’s confidence in the Indian economy. The central bank highlighted a few positive factors about the economy:
  
       - Improving capacity utilisation and credit off take
  
       - Robust investment and construction activities
  
       - Healthy consumption in both rural and urban areas (could even strengthen further)
  
       - Buoyant global demand that could encourage exports and investments
  
       - Revival in domestic economic activity
  
  This paints a positive picture for economic growth. But what it does is clear any arguments for a potential cut in interest rates for the purpose of stimulating growth. This means that in case inflationary pressures continue or worsen, the RBI has enough room to hike interest rates again in future.

What does it mean to you as an investor?

Stock markets usually do not appreciate increase in interest rates. This is for a number of reasons. (You can read about this here)
Plus, there are many stocks that are more sensitive to interest rate fluctuations. A simple example of this could be companies that have high interest payments. Loans, for such companies, could turn costlier—and thus, affect their profit margins.

So, it’s important that you keep an eye on all the factors mentioned by the RBI. This will help you map the trend in inflation and form an expectation for future interest rate hikes and cuts.

You may also want to refer to the latest stock recommendations by our experts. To get the list of stock recommendations, click here.