Rate hike: loans set to get costlier

Rate hike: loans set to get costlier

Stumping bankers, analysts and those who had professed status quo in the policy rates, the six-member Monetary Policy Committee (MPC) has increased the repo rate to 6.25% from 6%.

The increase in the rate has come after four and a half years, the first in the Narendra Modi regime. Interestingly, the decision to hike the repo rate was unanimous, with neutral stance and, surprisingly, dovish tone, may be to calm the ‘money market’.

The rationale for the increase in the repo rate is the sharp rise in the CPI core inflation (excluding food and fuel) at 5.3% in April as against 4.5% in March. The headline inflation is also up at 4.2% in April from 3.9% in March. Within the food basket, inflation has increased in respect of fruits, cereals, fish and meat.

To validate the MPC’s predicament, the projections of CPI inflation has again been revised in the range of 4.8-4.9% in H1 FY19, including the impact of the 7th Pay Commission largesse and 4.7% for H2 FY19. The bandwidth for H1 2018-19 was 4.7-5.1% and 4.4% in H2 as per the MPC forecast in the April monetary policy.

The MPC is also seriously concerned about the upside risks of inflation on account of the sharp increase in crude oil price, touching $80 per barrel as against $68 per barrel during the last policy review, which has a cascading effect on domestic transportation costs leading to increase in food prices.

However, the MPC has maintained the GDP growth forecast of 7.4% for 2018-19 as announced in the April policy, since Governor Urjit Patel and the MPC are convinced on the growth trajectory which has been positive, though nascent.

The MPC is confident of substantial recoveries from stressed assets referred to NCLT, which will result in substantial ‘write back’ by the banks whose balance sheets have virtually bled. As of March 2018, 22 public sector banks had posted a cumulative loss of Rs 85,167 crore.

Coinciding with the policy announcement, the President has given ascent to a significant ordinance under the Insolvency and Bankruptcy Code (IBC), which brings apartment-buyers under the status of ‘financial creditors’ in the insolvency process of builders, allowing them to participate in the proceedings of the Committee of Creditors, thus making the opaque real estate sector transparent and putting recoveries on fast track.

The repo rate — the rate at which the banks borrow from RBI — is increased to 6.25%. Consequently, the reverse repo — the rate at which RBI borrows from banks — moves to 6%. The cash reserve ratio (CRR) — the share of deposits which banks must park with RBI without earning any interest — remains unchanged at 4% and the Statutory Liquidity Ratio (SLR) — the ‘reserves’ banks are required to maintain in the form of gold or government-approved securities/bonds – remains at 19.5%.

Dearer EMIs

The increase in repo rate will trigger upward revision in the Marginal Cost of Lending Rate (MCLR) by the banks (a few big banks have already done so). This will lead to increase in the home loan rates for the new borrowers, making EMIs dearer.

Borrowers who are on the ‘base rate’ prior to April 2016 may also get hit by the increase in EMIs/ tenure extension on account of hike in rates. The same holds good for the Housing Finance Companies (HFCs) who are on ‘base rate’ or their own prime lending rates (PLRs) and not on MCLR. Banks will now increase the rates on fixed deposits for longer tenures.

To promote affordable housing under the Prime Minister Awas Yojana (PMAY), the eligibility criteria under priority sector lending by the banks, for housing loans, has been revised from the existing Rs 28 lakh to Rs 35 lakh in metro centres (population of 10 lakh and above, with a cap on cost of construction at Rs 45 lakh) and from Rs 20 lakh to Rs 25 lakh in non-metros (construction cost cap of Rs 30 lakh).

The same criteria should be extended to HFCs by the National Housing Bank (NHB). This will have dual benefit of reduction in interest rate for home loan borrowers under this segment and will also get the cash-linked subsidy under the PMAY scheme in the range of Rs 2.2-2.5 lakh. Builders who take up such affordable housing ventures will get construction finance at reduced rates and tax-breaks.

However, the MPC has raised a red flag on the increase in the level of NPAs in the affordable housing loan segment below Rs 2 lakh. RBI has cautioned banks/HFCs to exercise proper due diligence and will come out with guidelines to restrict the loan to value/cost ratio (LTV/LCR) or increase the risk weightage/provisioning to prevent serious delinquency in this vulnerable segment.

The increase in the repo rate, coupled with the MPC’s neutral stance, though intriguing, is a clear signal that the RBI is keeping its options open – to further hike rates during the year.

(The writer is a Bengaluru-based economist and banker)