As the Reserve Bank of India (RBI) governor started articulating the policy review meeting outcome, participants were focused on a potential interest rate hike and the guidance on rate measures. As we have discussed in similar columns earlier, it was expected to be more of a rate ‘normalisation’ than the usual concept of rate hikes. Interest rates were brought down to ultra-low levels by the RBI to help the economy fight the pandemic-induced slowdown. Now that the economy is out of ICU and normalising, rates also have to be ‘normalised’. It was a positive surprise for the markets as not only were rates not hiked, the monetary policy committee (MPC) maintained the accommodative stance, which means a tilt towards maintaining rates on the lower side.
On top of these, there was another ‘gift’ for the market. In every policy review meeting, the MPC gives out projections for inflation and GDP growth. The projected CPI inflation for the coming financial year, 2022-23, is 4.5 percent, which is much lower than what economists/analysts expected. This has cheered both the equity and debt markets. It should cheer our readers as well, as relatively lower inflation would be less taxing on your pocket. However, this is to be taken little conservatively as actual inflation in 2022-23 may turn out to be little higher than 4.5 percent, given high global crude oil and other commodity prices. Nonetheless, given that the RBI is giving out a projection after due research, means inflation would be more benign than what we are given to believe as per prevailing commodity prices, which is a positive takeaway for all of us.
Net-net, where do we stand on the issue of potential interest rate hikes? It will happen, it is a matter of time. The major parameter for the RBI to decide on rates is inflation, apart from other parameters like GDP growth, current account deficit, level of the rupee, global interest rates, etc. Given that inflation projection is lower than earlier, it may seem that rate hikes have been pushed back or may not happen to the extent we thought earlier.
Having said that, interest rates are at an all-time low, and it cannot sustain at these levels forever. Real interest rates, i.e., returns from fixed income investment products net of inflation, have been negative for some time. It is the job of the central bank to even out the needs of savers/investors seeking high interest rates and borrowers seeking low interest rates. Though the RBI cannot guarantee real positive rates, it has to take measures to strike a balance. In an unprecedented situation like the pandemic, interest rates were lowered to emergency low levels, at the cost of real negative rates. Now we have to move towards real positive. With inflation expected to be lower than earlier, rates need not be hiked as much in the rectification process.
Where does this leave us, on the ground? For borrowers like those who have availed of home or personal loans and the like, there is more of a breathing space, as rates are not going up in a hurry, at least not as fast as we thought prior to this policy review. For investors in deposits such as bank term deposits, a few lenders have marginally hiked deposit rates as the RBI has given subtle hints earlier about policy rate normalisation. But these are token steps, not making any meaningful impact. The benign outlook of this policy review means an increase in deposit rates has been pushed back. For people depending on interest from bank deposits, the wait gets longer.
For investors in debt mutual funds, yield levels on bonds in the secondary market had moved up after the Union budget on very high government borrowing projected for 2022-23. This had an adverse impact on returns from bond funds in the recent past, as yields and prices move inversely. After today’s encouraging policy review, yield levels have eased and the impact on debt funds is positive. However, as a result of significant interest rate cuts earlier, the accrual level of debt mutual funds—the level at which interest accrues to these funds—is not attractive, not when compared with prevailing inflation. Going forward, as and when interest rates move up—perhaps to a lesser extent than we thought earlier—the movement in that phase would be adverse but, thereafter, the accrual level will be that much better.
The equity market has cheered the policy review, as low interest rates and a relatively lower inflation projection are positives for corporates, consumers and investors.
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