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  • RBI committee hikes borrowing rates by 0.25%: Things to know

    Publish date: 02nd August 2018

    The Monetary policy committee (MPC) of the Reserve Bank of India increased the repo rate by 0.25% to 6.5% in its bi-monthly policy on Wednesday. However, the committee has maintained a ‘neutral’ stance. Rates were hiked consecutively for the second time this year. It is the first time the committee has announced a back-to-back rate hike since 2013.

    The present state of the economy

    India’s economy is currently witnessing rising retail inflation and declining factory output, policy statement said. Inflation is hovering above RBI’s medium-term target of 4% for the past eight months. It is expected to stay up there till the end of 2019, according to the RBI committee statement on the inflation outlook.

    With Union Cabinet’s announcement on MSP price hike for all kharif crops, there is a rise in inflation expectation, the committee observed. Volatility in the crude oil prices and global financial markets may also be a reason for the hike in the repo rate.

    Why raise rates now?

    Repo rates are the interest rates at which the RBI lends short-term money to the commercial banks. These rates are increased in order to control inflation.

    The committee has observed that several high-frequency indicators of services activity increased at a faster pace in May-June 2018.

    “The services PMI expanded to a twelve-month high in June, after a marginal contraction in May, supported by expansion in new business and employment,” the RBI release said. While this is good news from an economic growth standpoint, an increase in demand puts a pressure on the inflation rate.

    Related read: 5 things that the IIP, inflation and PMI numbers say

    Impact on Stocks

    Benchmark indices like Sensex and Nifty fell soon after the monetary policy announcement. With loans becoming more expensive, the cost of capital for companies increase. This can have an impact on their profitability. As markets are based on expectations, investor’s sentiments about the company’s profits in the future can be affected. Thus, share prices of interest rate-sensitive sectors like banking, automobile, capital goods could remain under pressure.

    Related read: RBI Outlook and the Stock Markets: How are they related?

    Impact on Bonds

    Bonds to a layman may be described as loans taken for capital development. When interest rates rise, the company can be required to pay higher interest rates if it has to borrow. But, newer bonds with higher interest rates are likely to be more in demand than the ones with lower interest rates. Thus, bond prices can go up. As bond prices and bond yields have an inverse relationship, yields can fall.

    Learn more about why stock market investors should track bond yield movements here

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