Rate hike on expected lines, but analysts curious on next step

Most analysts said the hike of 25 basis points on repo rate and reverse repo rate by the RBI was on expected lines.

While market discounted the latest rise, what worries the analysts is the future stance of RBI, as most say the central bank is still hawkish.

According to Nomura, the tug-of-war between growth and inflation will intensify.

“The slowdown that started with industry and weakened investments is feeding into services with moderation in consumer durables. Despite more than 400 basis points of effective tightening over a 14-month span, WPI inflation has remained high at 9.1 per cent y-o-y in May compared to 10.5 per cent a year ago, raising the question of why rate hikes have not yet been effective,” said Ms Sonal Varma of Nomura.

“One reason is that fiscal policy, by raising farm support prices and boosting rural incomes, is offsetting the impact of higher rates. Therefore, there is an asymmetric impact of tight policy, with investment falling while consumption demand is less affected. Additionally, the WPI basket is dominated by commodities and even the RBI's measure of core inflation – non-food manufactured WPI – is a mix of input and output prices. So, unless commodity prices ease, inflation should persist.”

According to BNP Paribas, the direction of the RBI policy action is clear; rate normalisation to levels somewhere near the pre-2008 financial crisis.

The repo rate was at 9 per cent in October 2008, prior to the rate cuts.

As the RBI says, the pass through of global crude prices is far from complete and from that perspective, there is still some upside risks to inflation. In this situation, there was no other way out for the RBI but to hike rates. The question now is how many more rate hikes and would there be a pause in the next Review Meeting.

The economy will go through a phase of adjustment over the next few quarters — adjustment to higher interest rates and sacrificing a part of growth to achieve an acceptable level of inflation, BNP Paribas analyst added.

“25 basis point hike in policy rate was on expected line. Based on monthly trend of non-food manufacturing sector inflation rate, the probability of couple of more hikes in the rest of the year is high. Although RBI started tightening from March 2010, its transmission to consumer was not immediate. Banks have started increasing their base rate/prime lending rate, which will help in cooling demand and control inflation,” said Mr Devendra Kumar Pant, Director, Fitch Ratings.

Mr Shanu Goel, Senior Research Analyst, Bonanza Portfolio, said: “The rate hike was as per the market expectations and the stock market acknowledged the acceptance with a sharp rise in Nifty of almost 20-25 points. Good buying was witnessed in banking stocks which further aided the uptrend. Nifty touched the intraday high of 5447.50 before slipping down to the pre-policy 5405-10 levels. Initial reaction of the equity market was favourable, however, the uptrend was short-lived in the absence of any optimistic signals regarding growth and curbing inflation. With no clear trend emerging from IIP numbers and monetary policy announcement, market sentiments are likely to be affected by global cues. Market is likely to consolidate in a range of 5350-5600,”

Mr Rajat Rajgarhia, Director-Research, Motilal Oswal Securities, said: “The 25 basis point rate hike by RBI was on expected lines. RBI's stance remains anti-inflationary and we expect further rate hike in the next policy. Impact of last few hikes is visible on growth estimates, leading to earnings downgrades for Corporate India. While Inflation trends have remained concerning, recent correction in global commodities should have some positive effect in second half.”

Angel Broking said: “We believe that the lending rates are likely to peak at a lower level in this cycle compared to the previous one as the inadequacy of forex inflows in this cycle is likely to lead to a weaker demand momentum. We expect the lending rates to peak at about 50 basis points from the current levels. Hence, we maintain our positive stance on the banking sector, taking into account the still healthy credit demand and good earnings visibility for large banks.”

However, according to Nirmal Bang, “Although the immediate impact of the increase in rate has been factored in by the markets and the banking stocks have showed a positive movement, the future of banking stocks would depend on how much they are able to pass on the increasing cost to the customers. We believe that the banking stocks will be impacted negatively over the medium term and also the other interest sensitive stocks like auto will witness some pressure over the medium term.”

COMMENT NOW