The Reserve Bank of India (RBI) has hiked the repo rate, the rate used to signal interest rates in the economy, by 2.5% in a pretty short span of time, between May 2022 and February. It may not convey much, when we look only at this data point of 2.5 %. However, it is significant.
Going by the history of rate action, this is much faster than the earlier rate cycles. Moreover, when we look at the base i.e. repo rate prior to the current hike cycle, it was 4%. It implies that in a way 63% (2.5 divided by 4) of the base has already been ticked up. This may not mean much, as the base was at an all-time low, pandemic-induced. And the repo rate is a function of inflation and other relevant variables of the day. Nonetheless, it gives a perspective that India’ central bank has already covered most of the path required to be travelled, in the context of current inflation levels.
A lot has been made of the reduced interest rate differential between India and US. That, in reality, is not as big a variable for RBI’s MPC as popularly perceived. If it is about FPI investments in bonds in India i.e. higher interest rates in India would induce FPI investments, the fact is, they hold only a miniscule component of outstanding stock. In government bonds, FPIs hold less than 1% of the outstanding stock of ₹91.4 trillion, at ₹0.76 trillion. In corporate bonds, they hold 2.6% of the outstanding stock of ₹40.9 trillion. There is no compelling reason to hike rates just to woo them. Then comes the issue of interest rate support of our currency. The theory is that higher interest rates would induce investment flows into India, thus strengthening the rupee. The fact, however, is that investments by foreign portfolio investors (FPIs) in equity in India is multiple times higher than FPI investments in bonds. Equity investments are driven by growth in India, which is supported by lower interest rates, rather than higher interest rates.
Somewhere down the line, our growth needs to be taken into consideration by the MPC. We are the fastest growing major economy in the world, but we are in the phase of economic rebound post-pandemic, moving into trend growth rate. Projections for GDP growth in the current year, FY2023, is 6.8-7 %, but range of projections for next year are lower, broadly 5.5-6.5%.
When we look at action in the last MPC meeting on 8 February, we see that two external members in the six-member committee have opined against further rate hikes, in the interest of growth. Globally, sentiments are changing on banking sector issues. The next meeting of RBI MPC is on 6 April. In any of the meetings, as and when another member changes view, then the Governor has the casting vote on a 3:3 situation. What does all this mean for you? Interest rates prevailing in the market have factored in the RBI rate hikes already done, and to an extent, the potential rate hike on 6 April. Bond yield levels may inch up a tad, but more-or-less, we are at good levels to enter.