Will Rate Hike Hit Retail Borrowers Again in August?
Sumit Sharma 24 July 2018
Acche din for Indian borrowers seem to be fading fast, as the cost for acquiring homes, cars, washing machines, among others gets costlier.
Following the first increase in June of its key repo rate since the National Democratic Alliance (NDA) government assumed office in 2014, the Reserve Bank of India (RBI) may raise the rate yet again in its monetary policy review on 1 August 2018. 
The RBI raised repo rate by 25 basis points (bps) last month to 6.25%. Bankers and economists predict the central bank may push up the rate further by another quarter percent after its Monetary Policy Committee (MPC) meeting on 30-31 July 2018.
A 50 bps increase, or half a percentage point in two months will push up yield on government and corporate bonds, the cost of borrowing for banks, and thereby the cost for companies and individuals.
The 10-year government bond yield has risen to 7.78% from 6.38% in January, 2017, sniffing 8% last month. The 10-year US bond yield too rose past 3.13% in June from 2.45% in January 2017. Higher yields from the local and US, make it costlier for banks and companies to raise funds.
Fuelling inflation further is the government's decision to raise minimum support prices on paddy and other kharif products and cut goods and services tax (GST) on 29 items, 53 services, reducing its revenue and increase expenditure. 
The increase in equated monthly instalment (EMI) of loans being repaid by home owners could discourage new buyers, hurting demand for homes. Likewise, the positive impact of slashing of GST on washing machines, and refrigerators, among other durables by the government last month too may get subdued for those buying these products on borrowed money.
For existing EMI payers, industry experts recommend the homeowners retain the length of their loan maturity instead of increasing it to soften the immediate impact of higher rates.
Yet, borrowers must realise that increase in RBI's repo rate is based on data inputs and hence typically more steady in its long-term direction.
A key element influencing the MPC is consumer price inflation (CPI). The CPI as of June had accelerated to 5%, the highest since January, and fourth successive month of rise. CPI is higher than the RBI's medium term mandated target of 4% for the past eight months. Yet, to be sure, the RBI has the leeway of up to 6%.
During June, rising global crude oil price was a key factor in influencing RBI's decision. Brent crude, which rose to as high as $80 per barrel in May, is currently trading at $73 per barrel, compared with $50 per barrel in August last year.
A stinging threat on Monday by US President Donald Trump to Iran could shake oil producers and directly hurt India. This is because Iran is India's second largest crude oil supplier after Iraq. Oil supplies from the Middle East are more cost efficient for India. Any rise in oil prices pushes inflation leaving RBI little choice but to raise rates.
A RBI study shows that every 100 basis points increase in borrowing costs lowers the investment rate by as much as 91 basis points.
In its Financial Stability Report (FSR) released last month the RBI said, ''Spillover risk from advanced financial markets to emerging markets has increased. Tightening of liquidity conditions in the developed markets alongside expansionary US fiscal policy and a strong US dollar have started to adversely impact emerging market currencies, bonds and capital flows.''
Overseas bond investors have pulled out Rs41,329 crore selling bonds and Rs20,967 crore from equities since April, compared with purchase of debt worth Rs1.19 lakh crore in the previous financial year to March, and Rs25,635 crore of equities, thereby reducing local liquidity and also weakening the rupee.
“Firming commodity prices, evolving geopolitical developments and rising protectionist sentiments pose added risks,” the RBI had said, adding “On the domestic front, economic growth is firming up. However, conditions that buttressed fiscal consolidation, moderation in inflation and a benign current account deficit over the last few years, are changing, thereby warranting caution.”
Since the beginning of 2017, prices of coal, natural gas, crude oil, have risen by between 10% and 25%. Price of fertilizer, aluminium, copper, tin, lead, and zinc too rose while that of iron ore edged down.
In all, increase in interest rates raises issues for individual investors across their investment spectrum. While cost of borrowing rises, investors must re-evaluate fixed maturity plans (FMP), debt funds, bonds holdings and fresh purchases, bank deposits to avoid losses and making the best of a potentially negative situation.
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