Not in your Interest

As the tussle between stubborn inflation and the Reserve Bank of India (RBI) continues, be prepared for a double whammy. You can expect another round of increase in bank lending and deposit rates when the RBI continues with its calibrated monetary tightening in its quarterly policy review on 26 July 2011. As the RBI squeezes liquidity from the system, your monthly out-go towards loan repayments will go up along with increase in household expenses.

If the RBI increases the repo rate in its coming quarterly policy review, it will be the 11th hike since March 2010.

After taking the market by surprise with a repo rate (at which it lends to banks) hike of 50 basis points(bps) in May 2011, the central bank had raised the repo rate by 25 bps in its June mid-quarter review.

The RBI has been unsuccessful in reining in inflation despite repeated hikes in the repo rate. In June 2011, the Wholesale Price Index (WPI)-based inflation was at 9.4%, up from 9.1% in May 2011 and 8.66% in April 2011. One basis point is one-hundredth of a percentage point.

The repo rate still does not fully account for the fuel price hike done on 26 June 2011—diesel prices were raised by 9% and prices of LPG (liquefied petroleum gas) and kerosene by 14.8%. According to a Citi Group report, with diesel, LPG and kerosene accounting for 6.3% of the WPI, the price hikes would push inflation by around 70 bps. Analysts say inflation is likely to average 9-9.5% in the current financial year.

According to Ajay Parmar, head of research at Emkay Global Financial Services, the policy rate can go up by additional 50-75 bps in the current fiscal if the RBI continues with its anti-inflation stance.“If the repo rate goes up, bank deposit and lending rates are likely to go up since banks will pass on the increased rates to customers as liquidity conditions are tight and credit demand continues to be good,” says V.K. Vijaykumar, investment strategist, Geojit BNP Paribas.

Banks have already hiked their lending and deposit rates to reflect the past increase in policy rates. State Bank of India, the country’s largest lender, increased its base rate (the benchmark interest rate which is the minimum lending rate of a bank) by 25 bps to 9.5%. The bank also increased its fixed deposit rates up to 100 bps across various maturity tenures.

ICICI Bank and HDFC Bank have also hiked their base rates by 25 bps to 9.5%. Oriental Bank of Commerce increased it base rate from 10% to 10.25%.