Banks brace for rate hike as inflation worry remains

The banking sector is bracing itself for a rate hike of 25 basis points in the mid-quarter review of the Reserve Bank of India scheduled for Thursday (March 17).

The RBI has so far hiked rates seven times during the last one year and pushed its repo rate (the rate at which it provides liquidity to banks) to 6.50 per cent. Effective rates are up by 3.25 percentage points (or 325 basis points) because the policy rate or the operating rate shifted to repo on account of the tight liquidity situation. (Banks were earlier parking their surplus or lending their money to RBI in reverse repo auctions at lower rates during times of ample liquidity in 2009.)

Given the immediate backdrop of the tsunami and the unfolding nuclear catastrophe in Japan and its impact on global markets, one would, expect the RBI to press the ‘pause' button in its rate tightening cycle. Commodity and stock markets have taken a beating everywhere. A further hike in repo and reverse repo rates of the RBI would presumably make markets more nervous.

But the dominant concern over the past year has been and continues to be high inflation. With the latest (February) Wholesale Price Index number coming in at 8.3 per cent, most analysts have been surprised by the upside, expecting that it would be around 7.5 per cent. The consensus now is that higher food prices are no longer the main driver of inflation – but that manufacturing good prices have contributed the most to it.

Further hikes ahead

There may be no respite in the immediate future considering that oil price hikes may be passed on over the next few months depending on the schedule of State Assembly elections. This could only keep inflation expectations high for a longer period. That would mean more hikes later in the year.

Although advance tax collections for the fourth quarter of the current fiscal show a decent increase for a number of top corporates, there is already an expectation that because of higher commodity prices, higher interest rates and higher wage increases, most companies would have their margins squeezed next year. Cost of funds for banks is also on the rise as they scramble to mop up short-term funds as part of the year-end ritual. Banks have begun passing this on to borrowers as they start hiking their base rates. You should therefore get ready to pay a little more on your home loans, car loans and personal loans.

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