There Would Be A Further Hike Of 50 Bps In The Year: BoB Chief Economist

In a surprising move on 4 May 2022, the Reserve Bank of India (RBI) increased the repo rate by 40 basis points. Now the repo rate has increased from 4 per cent to 4.40 per cent. RBI had last cut the repo rate in May 2020 and left it stable since then. But the unscheduled announcement on rise in repo rate and CRR has taken everyone aback.

"This is indicative of the fact that there would be more such action taken over time depending on the evolving inflationary situation. We had expected 50 bps increase in repo rate in CY2022 but would now believe that there would be a further hike of 50 bps in the year", says Madan Sabnavis, Chief Economist, Bank of Baroda.

Understanding Repo Rate

Just like borrowers have to pay some interest for taking loans from banks, similarly financial institutions also have to pay interest on money borrowed from the Reserve Bank. This interest is called the repo rate. The word 'repo' is an abbreviation for 'repurchasing option' or 'repurchase agreement'. Under the arrangement, scheduled commercial banks provide securities such as treasury bills or gold to the RBI for overnight credit in case of liquidity crunch.

Repo rate is also powerful weapon of the monetary policy of India that can control country's money supply, inflation levels, and liquidity.

Sabnavis says, "The hike in repo rate will help to quell the build-up of excess demand pressures and hence slow down the growth in inflation though it cannot affect some of the components that are driven by global factors.

The overarching focus on inflation is significant as it goes back to the normal mandate of the MPC which is to curb inflation as growth seems to be better placed today. But not tackling inflation now, growth can be jeopardized. This will be the main message from the so-called interim policy announced."

How does it affects Banks & Customers?

Chief Economist of BoB, Madan Sabnavis well explains that what does RBI's repo rate mean to the banks and their customers.

He says that loan borrowers are affected depending on the terms of the engagement with their banks. In case their loans are linked to an external benchmark, which is the repo rate, then there will be an automatic increase in the interest rate. If it is linked to the MCLR then it would depend on how the MCLR formula has moved.

If banks raise deposit rates which increase cost of funds, then the MCLR will also increase thus increasing the cost for the borrower. As deposit rates are never increased by same extent of repo rate, the latter modality of linking with MCLR will see a smaller increase than loans linked directly with repo rate.

How does it tackles Inflation?

RBI Governor, Shantikanta Das while making the announcement emphasised that their monetary policy actions is aimed at lowering inflation and anchoring inflation expectations. It will strengthen and consolidate the medium-term growth prospects of the economy.

Inflation in India is brought about by the new upsurge in crude oil costs and supply-chain interruptions. The Covid pandemic has additionally sped up the pace of inflation in the country which has led to rise in retail inflation rate to 6.95 per cent in March.

Sabnavis on this says, "As repo rate rises, cost of funds will go up which will help to curb excess demand forces. Only companies which see vibrant demand will invest as cost of funds goes up. Therefore there will be a slowdown in growth in credit as well as overall growth, which is the objective to curb inflation growth. As growth slows down there are less excess demand forces and price increase is controlled."

After the increase in RBI's repo rate and CRR, many banks have started increasing different interest rates.