There is something that has gone unnoticed in the Reserve Bank of India’s (RBI) bi-monthly monetary policy. The central bank has indirectly raised interest rates in the system through the standing deposit facility (SDF), setting the ground for hikes across the spectrum.

After a long spell of low interest rate regime, India may be inching to a higher loan pricing structure. So, unlike what many people believe, do not get surprised if banks price corporate loans higher despite there being a sluggish demand for it. Even home loan and deposit rates are going to inch up.

The RBI has placed the standing deposit facility (SDF) at 3.75% as the floor price for banks to park money with the central bank. Earlier, the variable reverse repo rate (VRRR) at 3.35% was the floor price. Banks will, in other words, be able to earn a higher rate with the money parked in the central bank. The SDF will be the tool that the central bank will use to suck out excess liquidity from the system.

When RBI starts giving higher rates for the excess money that banks put with the central bank, it will push up interest rates in the system. Call rates will be up and fund cost for banks will rise.

As bank deposit rates climb, this will push up MCLR rates (marginal cost of funds-based lending rates). Corporate credit rates will also rise as most of it is linked to the MCLR rate, CS Setty, State Bank of India managing director of retail and digital banking, told Indianbankingnews.com.

The interest rates on loans are set to harden. Said Punjab & Sind Bank executive director Kollegal Raghavendra, “RBI has signaled a shift in stance from accommodative to a more hawkish position. Again, with the setting up of the  SDF, the central bank has actually raised the interest rates on the deposits it takes from the banks. The interest rates are set to harden from here on. Home and car loan rates will all go up, but the timing will depend on the demand and supply situation.”

In the bi-monthly monetary policy, the RBI has kept the repo rate unchanged at 4%. The marginal standing facility (MSF) at 4.25% continues to be the ceiling at which banks can park money with the central bank.

“While there was no increase in repo rate, the central bank moved the SDF and MSF corridor to 3.75% and 4.25%, respectively. In essence, overnight rates have been hiked to 3.75%,” said Shanti Ekambaram, group president, consumer banking, Kotak Mahindra Bank.

The 40 basis points hike in the floor price is an effective rate hike which has already pushed up both the short-term and the long-term rates in the system. RBI has narrowed the corridor of the liquidity adjustment facility (LAF), the window through which banks park excess liquidity with the central bank.

Surprising the markets with its hawkish tone, the RBI said that its focus will be the gradual withdrawal of the easy money policy. The interest rate, specially of the shorter tenures, will gradually move up with the restoration of the LAF to the pre-pandemic level. “Already after the policy was announced, the long-term rates shot up by 20 basis points and the short-term rates were higher and likely to go up further,” said a treasury expert in a public sector bank.

With the SDF, the RBI has restored the LAF corridor to the pre-pandemic levels. “The rates will move in a narrower range of 50 basis points lower than the 90 basis points range that was available during the pandemic,” said a banker who did not want his name to be revealed.

The swap yields are up. “While the immediate market price action reflects a lot of positioning pains, nevertheless it is noteworthy today. Swap yields are up 30-40 bps. This is over and above an already reasonably large rate hike cycle that they were already pricing,” said Suyash Choudhury, head of fixed income, IDFC AMC.

Despite growth remaining a worry, inflation has become the main concern of the RBI even as Russia continues to pound Ukraine and the price of crude oil climbs. The RBI revised upwards its inflation forecast to 5.7% this fiscal from its earlier guidance of 4.5%.

“In the sequence of priorities, we have now put inflation before growth. Time is appropriate to prioritise inflation ahead of growth," said RBI Governor Shaktikanta Das.

Inflation is expected to average 6.3% in the first quarter of this fiscal; 5.8% in Q2; 5.4 % in Q3; and 5.1% in Q4.

“This is clearly a hawkish policy as compared to the February meeting of the MPC (monetary policy committee), justified by the inflationary pressures that have emerged over the past month. The upward inflation forecast revision by 120bps to 5.7% for FY23 seems sensible given the broad-based nature of price hikes,” said Abheek Barua, chief economist at HDFC Bank.

A repo rate hike is very much on the cards in the next bi-monthly monetary policy. Said Choudhury, “It puts prospects of a repo rate hike very much on the table for June.”

Radhika Rao, senior economist at DBS, believes the first repo rate hike would be delivered in August and thereafter towards end-2022. “We retain our expectations for 75bps worth rate hikes in FY23, concentrated in second half of the year. Local considerations will still trump global policy normalisation. Even in the face of the US Fed pursuing an aggressive rate hiking cycle, it is amply clear that the RBI is unlikely to respond with a larger or faster quantum of hikes,” she said.

Growth is another area of concern for the RBI. For FY2023, the RBI cut its GDP growth projections to 7.2% from 7.8%. This has come on the backdrop of heightened geopolitical tensions and spike in crude oil prices.

An important announcement is the hike in held-to-maturity (HTM) category for FY23 to 23% from 22% of NDLT earlier. Banks will also be allowed to include eligible statutory liquidity ratio (SLR) securities acquired between April 1, 2022 and March 31, 2023 under this enhanced limit. Thereafter, the HTM limit will return to 19.5% in a phased manner starting from June 30, 2023.

“It is gratifying to note that our (IBA) representation is addressed by the RBI. This extension will create additional space to support the government borrowing by banks,” said Indian Banks’ Association (IBA) chairman AK Goel, who is also the MD and CEO of Punjab National Bank.