Loans may cost more as RBI hikes rates to combat inflation

The Reserve Bank on Thursday raised key policy rates by up to 50 basis points for the fifth time this year, a decision that will make loans expensive and help check inflation, but give better returns to small savers.

As part of its first mid-quarterly review of monetary policy, the RBI upped its key short-term lending (repo) rate by 25 basis points and borrowing (reverse repo) rate by 50 basis points to 6 per cent and 5 per cent, respectively.

The decision has been guided by the need to contain inflation, which is currently at 8.5 per cent (food inflation has touched 15.10 per cent), as a hike in rates will lead to a rise in cost of funds for banks and will make loans expensive. This, in turn, will reduce consumption.

"Rate of interest may have to go up. Banks have to take a view at the end of the quarter. Till September 30, I do not expect any change. Pressure is there to increase rates in the near term", said Bank of Maharashtra chairman and managing director Allen Pereira.

"In early October, there could be some revision in interest rate...the credit offtake, deposit inflow and what competititors are doing -- all these business considerations will come into play for deciding the rate hike", said R K Bakshi executive director of Bank of Baroda.

Similar views were expressed by executive director of Punjab and Sind Bank, P K Anand who said, "Till September 30 everyone will hold on to the interest rate. (After that) there might be a pass on effect to customer."

Following the hike in repo and reverse repo rates by a similar margin in July, the fourth time then during the calendar year, 40 banks raised deposit rates and 29 lending rates.

The RBI too wants deposit rates to go up as there is a need to make the real interest rates, the difference between inflation and deposit rate, positive. "...real interest rates need to move in the direction of encouraging bank deposits", the central bank said.

Industry chamber Ficci also expressed the fear that rising interest rates would hit business.

"Increasing repo rate is another signal of rising the cost of borrowing...hopefully it is the last such... restrictive action towards growth. We hope to see this restrictive policy eased in the next round", said Ficci secretary general Amit Mitra.

Expressing concern over the RBI move, PHD Chamber said, "This will adversely impact the cost of borrowing by the industry from the banks, especially by the SMEs. It may also the cost of home loan as well as consumer loans."

For RBI the major concern in inflation as "headline inflation remains significantly above the trend of 5.0-5.5 per cent in the 2000s.

"Inflation remains the dominant concern in macroeconomic management... (there is) need for continued policy response to contain inflation and anchor inflationary expectations," the RBI said.