Home & auto loans to pinch more as RBI raises key rates 50 bps; corporates frown on move

Subbarao Takes a Giant Leap of Faith, Leaves All Stumped Reserve Bank of India Governor Duvvuri Subbarao took a leaf out of his predecessor YV Reddy's book to shock investors and industry by raising interest rates double the expected to 'maintain the credibility', but it will blow a hole in household budgets and corporate balance sheets. Funding cost of nearly everything from homes and cars to building roads and utilities will climb. But a demand slowdown may temper future price rises and help sustain a stable economic growth over the long term. YES Bank took the lead in hiking rates, and others said they would follow soon. Stocks and bonds fell, but the rupee rose against the dollar expecting overseas investment in highyielding fixed-income securities.  Inflation forecast was raised as the flawed pricing of petroleum products, coal and agricultural products could strain government finances and have the potential to worsen inflation. If softening global commodity prices reverse, or the monsoon falls short of requirement, prices could shoot up.      There is a need to continue with a 'firm anti-inflationary' stance as there is 'no evidence' of a sharp slowdown in the growth momentum as claimed by industry, said the central bank. Supply bottlenecks also need to be resolved if prices have to cool, it said, pointing to little help from the government in fighting prices.  "The Reserve Bank of India has sought to give a strong signal to further moderate inflation and check inflationary expectations," said Finance Minister Pranab Mukherjee. "With this policy adjustment, we will be able to get back to a more comfortable inflation situation."  Subbarao raised the repo rate—the rate at which he lends to banks—for the 11th time, by 50 basis points to 8%. The reverse repo—the rate it pays banks for investing excess funds with it—was raised by the same amount to 7%. The penal rate on lending to banks under the Marginal Standing Facility is up at 9%. Inflation forecast has been raised to 7% with an upward bias and non-food loan growth forecast lowered to 18% from 19%. A basis point is 0.01 percentage point. Economic growth rate is maintained at 8%. Cash reserve requirement and statutory liquidity ratio, however, remain unchanged.  Low & Behold the High Rates!  Although the RBI has raised interest rate for the 11th consecutive time starting March 2010, it doesn't mean a higher cost of capital—in real terms  Savers are earning negative returns: 1-year FD with SBI fetches 9.25%, whereas inflation in June was 9.44%—a negative interest of 0.19%  Borrowers  are getting money cheap too:  Prime borrowers are still getting funds at almost negative real interest rates--SBI's base rate is 9.5%  Savers are  subsidising  borrowers: Interest rates need to rise to provide positive inflation adjusted returns to depositors  Find funds abroad:  Businessmen are free to borrow from abroad at lower nominal interest rates. Companies borrowed $4.7b abroad in April-May  RBI's enemy is inflation:  Reserve Bank's mandate is to fight inflation even if it means sacrificing some growth  Government  isn't exactly helping: The ballooning public spending and subsidies are nullifying some impact of monetary tighteningINTEREST COSTS ARE NOT HURTING YET :Companies can absorb the increase in cost of capital without worrying about pressure on margins RBI ACTION AFFECTS BOTH INDIVIDUALS & INDUSTRY Home Prices to Fall on Costlier Loans Property prices are expected to correct around 20% following another round of tightening by RBI. Sensex Slumps 353 Points on Rate Hike The Sensex fell the most in more than a month after the rate hike, shedding 353 points to 18,518. Policy Actions Needed to Sustain Growth: RBI  "It is important to recognise that in the absence of appropriate actions for addressing supply bottlenecks, especially in food and infrastructure, questions about the ability of the economy to sustain the current growth rate without significant inflationary pressures come to the fore," the RBI said in the statement reviewing monetary policy for the June quarter. "The economy's ability to grow rapidly for any length of time without provoking inflation is dependent on implementing policies, with corresponding resource allocations, which will allow the supply of various products and services to keep pace with demand."  The central bank's move is contrary to market expectations. All the 15 economists and treasurers polled by ET were for a 25-basis-point increase and moderation in tone about future increases. Industry, including Ratan Tata, chairman of Tata Sons, was for a pause since economic expansion may stall. But the policy handed out the opposite of it. Inflation as measured by the Wholesale Price Index was 9.44% in June, and it possibly was above 10% given the upward revisions in the past.  The benchmark BSE Sensex slumped 1.9% to 18,518.22. The yields on 10-year benchmark government bond rose 14 basis points to 8.43%.The rupee closed at 44.18 per dollar against the previous close of 44.39 per dollar.  "Early corporate results for Q1 of 2011-12 suggest some moderation in margins," said Subbarao. "However, such moderation so far has been modest, implying that pricing power persists."  Hero Honda's net sales grew 32.3% in the June quarter and net profit rose 14%. Reliance Industries' revenue rose 37% and profit climbed 17%. Among lenders, HDFC Bank's net interest income grew 16% and profit after tax advanced 34%. Interest outgo as a proportion of sales for BSE 500 companies fell in FY11 to a three-year low of 10.1%, from above 11% in fiscal 2009, an ET Intelligence Group analysis shows. Corporates are not happy as their borrowing costs will go up as banks raise lending rates.  "Increase in lending rates is inevitable,'' said Deepak Parekh, chairman at Housing Development Finance Corp, the country's biggest mortgage lender. "At HDFC, we will review rates within a month. No institution can absorb a 50-bps rise in rate. It was unexpected. Indian industry is becoming uncompetitive, with high interest rates, high wage cost and rising raw material cost. This will be a big issue."  Industry has been lobbying for a pause in rates since there is a slackening of demand as captured in the Index of Industrial Production numbers, which the RBI does not trust and has termed 'analytically bewildering'. IIP grew 5.7% in April-May 2011, lower than 10.8% a year earlier, but these numbers have been erratic. Merchandise trade, however, registered strong growth with exports surging 46% in theJune quarter.  For 2009-10, the advance estimate of GDP growth at market prices from the expenditure side, which came out in February 2010, was 6.8%. That was changed to 7.7% in the revised estimate in May 2010, and again to 9.1% in the quick estimate in February 2011. Initial WPI estimates for were 8.2% and 8.3% for January and February, respectively. Both were raised by 120 basis points later.  Although the rate hike looks steep, some economists believe it may possibly be the end. "With this move, the RBI has significantly surprised the market with the rapidity and extent of its rate hikes," said Tushar Poddar, economist at Goldman Sachs. "Having burnished its anti-inflation stance, we believe there is little need for the RBI to hike further to enhance its commitment to fighting inflation and keeping medium-term expectations anchored."  Planning Commission Deputy Chairman Montek Singh Ahluwlia said the RBI's policy move was not improper. "You do need to send signals and if the situation improves, he can reverse the position later. It (the decision) is bound to be effective in controlling inflation," he said.  The next mid-quarter monetary policy review will be on September 16 and quarterly review on October 25. Govt Must Now Show Will to Act  Inflation hurts the poor, chokes growth and has to be contained. But is squeezing demand the only means to that end? The RBI does not think so. It would like the government to channel investment, directly or through decisive, clearheaded policy, to increase supply in key sectors such as milk, pulses, vegetables and coal. At the same time, government consumption should be contained, to curb fiscal deficit. If the government does not show sense or the will to act, the RBI has no choice to hike rates further — this is the message from Mint Street. The government should take heed, denationalise coal, invest in rural roads, free up agri marketing, and slash oil, fertiliser and power subsidies. The RBI cannot, need not, battle inflation on its own.