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Stock markets have followed a standard pattern of beating down banking stocks prior to every RBI policy review in recent months. They ran true to form this time too. This was despite the markets widely expecting the RBI to hike rates by 25 basis points, which it did.
After a further interest rate hike of 0.5 percentage points in the repo rate during its May credit policy, the RBI has reverted to a less severe stance by hiking repo rates by 25 bps in Thursday's mid-quarter monetary policy review.
This action would mean a slightly higher cost of wholesale short-term borrowings for banks as the monetary transmission in the system continues to be very effective. This is due to a liquidity deficit situation, with banks borrowing Rs 60,000 crore daily on an average during June 2011.
Hike already discounted
As the hike was on expected lines, neither the call rates nor the overnight interest swap rate witnessed any sharp volatility. The overnight interest swap rate, post the hikes, continued to remain at the level prevalent during the previous policy hike, indicating that another 50 bps of hike is expected over the next one year.
The rate hikes may continue despite moderation in industrial production activity and fall in GDP growth as the inflation is getting more broadbased (7.3 per cent year-on-year rise in core inflation).
While the recent fall in global commodity prices and a good monsoon would help increase the food supply and ease inflationary pressures, the current high rate may continue for some more time.
Impact on banks
Banks may respond to these changes by hiking lending rates further even as they try to keep deposit rates steady. Banks are already facing pressures in the form of higher savings account deposit costs on their margins.
The deposit inflows during the current quarter (till June 3) have been strong with around Rs 1.7 lakh crore of net deposit inflows. During the same period, the lending activity was lower with credit outgo of around Rs 38,000 crore.
Despite this, the repo borrowing continued to remain high. This indicates that a few banks are borrowing against excess SLR securities from the repo market and on-lending it to the call market.
If the RBI's rate hikes persist, apart from the margin pressures, banks have to handle the issue of interest rate risk affecting investment portfolios as well.
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