The long spell of ultra-low interest rates is over. The Reserve Bank of India (RBI) will have to carry out a series of interest rate hikes to counter inflation, implying that individuals and companies will have to shift to costlier loans.

In an off-cycle meeting, the RBI on Wednesday raised the policy rate by 40 basis points to 4.40%. The cash reserve ratio (CRR) rate will be raised by 50 basis points to 4.50% from 21 May. These measures of adjusting both the rate and the quantum of liquidity are set to control the second-round impact of inflationary pressures and an effort to anchor inflation expectations.

Steep and shockingly sudden as they are, the RBI will need to have more bouts of rate action during the course of the year. With the Russian onslaught against Ukraine continuing, there is no way that inflation will moderate in a hurry.

The RBI will have readied a roadmap for quantitative tightening, depending on the gravity of the geopolitical hostilities and the impact the war in Ukraine has on the global economy. India will have to rapidly transition to a higher interest rate regime.

The rate hike cycle has begun and bank lending will increase factoring in the risk. Having wafer thin margins in retail loans, banks will have little incentive in not passing, to a greater extent, the present and future hikes to customers.

Equated monthly installments (EMIs) will see upward revision as cost of funds for banks climb. With future hikes in benchmark rates, there would be an increase in MCLR (marginal cost of funds-based lending rate) due to negative carry. When the banks start raising the deposit rates, the cost of funds go up and so will the MCLR too.

“We believe the decision for rate hike will be ultimately good for the banking sector as the risk is getting repriced properly,” says State Bank of India (SBI) group chief economic adviser Dr Soumya Kanti Ghosh.

HDFC Bank chief economist Abheek Barua believes the RBI’s surprise move in upping the rates on 4 May was instigated by the upcoming April inflation print, which could come in higher than expected at 7.6%.

According to Barua, there is a case for a higher terminal policy rate in this rate cycle. “The sharper than expected rate increase by the RBI paves the way for a more aggressive rate hike cycle than we earlier expected. We expect three more rate hikes in this fiscal with the repo rate likely to end the year at 5.15%,” he says.

The RBI’s move should help in pushing real rates towards neutral over the next few quarters. “Rates across the curve will reprice factoring in a markedly more hawkish RBI. We continue to expect cumulative 100-125 bps of repo rate hikes in FY2023,” says Kotak Institutional Equities senior economist Suvodeep Rakshit.

ICRA chief economist Aditi Nayar sees a higher base softening the May 2022 CPI (consumer price index) inflation print considerably, although it will likely remain above 6%. “While a back-to-back hike in the June 2022 policy is not yet certain, we do foresee an additional 35-60 bps of rate hikes in the remainder of H1 FY2023. If a de-escalation in geopolitical tensions cools commodity prices, then we expect a pause to reassess the impact on growth, followed by another 25-50 bps of rate hikes in CY2023,” she says.

With inflation being a matter of global concern, RBI Governor Shaktikanta Das could no longer remain silent on it while staying focused on growth. In March, retail inflation stood at 6.95%, touching a 17-month high and breaching the RBI’s upper tolerance limit of 6% for the third month in a row. The wholesale price index (WPI), also on an upward curve, hit 14.55% in March from 13.11% a month ago. 

“The overarching focus on inflation is significant as it goes back to the normal mandate of the MPC (monetary policy committee) which is to curb inflation as growth seems to be better placed today. But not tackling inflation now, growth can be jeopardised. This will be the main message from the so-called interim policy announced,” says Bank of Baroda chief economist Madan Sabnavis.

Despite the rate hikes, inflation may continue to remain high for some time. The inflation dynamics play out on two sides in India. The inflationary pressures can be attributed mainly to adverse cost-push factors coming from supply-side shocks in food and fuel prices. On the other side, weak aggregate demand conditions continue to exert downward pressure on inflation.

“Measures to ameliorate supply-side cost pressures would be critical at this juncture, especially in terms of a calibrated reduction of taxes on petrol and diesel. This would help anchor inflation expectations, prevent build-up of a wage-price nexus and provide space for monetary policy to sustain support for the still incomplete growth recovery. On the policy side, it would mean that even after rate hikes, inflation may continue to remain high for some time,” says Ghosh.