On May 4, the Reserve Bank of India (RBI) stunned both the stock and bond markets by increasing the repo rate by 40 basis points (bps) to 4.4%. It was an inter-meeting escalation.
Repo rate is the interest at which the central bank lends to commercial banks. This is the first rate hike since August 2018.
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The central bank also decided to increase the cash reserve ratio (CRR) by 50 basis points to 4.5%. This roughly means that for each 100 out of the deposited amount, banks will have to keep it now. stock of 4.5 As compared to earlier with RBI 4.
These hikes stunned both the stock and bond markets. Benchmark indices Nifty 50 and S&P BSE Sensex lost 2.3%. The 10-year government bond yield rose 27 bps to 7.39%. Bond yield is the annual return that investors can expect if they buy a bond at a given point in time and hold on to it until maturity.
Bond yields hardly increase a few basis points daily. Yesterday’s jump was the highest since February 8, 2017, when yields increased by 32 basis points.
So what compelled RBI to increase the repo rate and CRR on the day of Life Insurance Corporation of India 21,000 crore initial public offering (IPO) opened?
The simple answer is that the central bank is finally waking up from its slumber on the inflation front. Of course, high inflation has been around us for some time now. It is just that the RBI under the leadership of Shaktikanta Das has refused to see it as fleeting.
Wholesale inflation has been in double digits since April 2021. Retail inflation stood at 5.5% in 2021-22.
As per its agreement with the Centre, the RBI is required to maintain retail inflation within the lower and upper tolerance levels of 2% and 6%, respectively, and ideally aim for a midpoint of 4%.
Since January 2020, retail inflation has been above 5% for most of the period and has remained close to the upper tolerance level of 6%. It has been anything but fleeting.
Of course, this is all known. So what could possibly have forced the RBI, which was more than careful not to disturb the finance ministry, led by Das, to wake up from its slumber?
It is likely that the retail inflation data for April, which is yet to be published, is off the charts. Apart from this, a meeting of the US Federal Reserve is being held on May 3-4. The market is betting that the Fed will raise its key short-term rate by 50 bps. Some are even betting on an increase of 75 bps.
Therefore, waiting till early June, when the next meeting of the RBI Monetary Policy Committee to decide on the repo rate is scheduled, may be too late.
In addition to increasing interest rates to curb demand, the RBI also seeks to reduce excess money circulating in the financial system, in the process, to reduce inflation.
By May 3, it was on 5.6 trillion. RBI hikes CRR and expects it to end 87,000 crore from the system. This will also increase interest rates.
Of course, this is the first of many interest rates to come. In view of this, the EMI on both the existing as well as the new loan will increase.
In fact, they are already on the rise. Interest rates on fixed deposits should also start rising, although banks are generally quick to raise lending rates but take their own sweet time when raising deposit rates.
Lastly, for those who were expecting good listing day gains from LIC IPO, the chances of this happening are slim now.