Tuesday, May 3, 2011

RBI Hikes Rates

The much expected RBI Rate hike exercise is complete and has caused a massive fall of over 300 points in the Indian stock market.

Well to be honest, I am not amused by this development, but nonetheless it is important news and has to be addressed just like other finance news that has been addressed in the past, in my blog.

So, lets get started!!!

Why did the RBI hike rates?

Well, the reason for the frequent rate hikes has been the inflation. The RBI as the monetary authority of india, has the responsibility of keeping our inflation at a stable rate and since inflation has gone up significantly over the past 2 years, they are taking steps to curb the Inflation.

An interesting statistic:

RBI has hiked rates 8 times since March 2010 and this is the 9th time.

What are the rates that RBI Hiked?

Repo Rate – The rate at which the RBI lends loans to banks was hiked by 50 basis points to 7.25%

The Reverse Repo Rate is pegged as usual at 100 points below the Repo Rate – i.e., 6.25%

Savings Bank Deposit Rates have been hiked by 50 basis points to 4%

Is this good news?

Well, to be honest, it depends.

If you are a loan customer, then it is bad news because all the EMIs on your floating rate loans are going to go up.

If you are a deposit customer, then it is good news because all your fresh deposits are going to earn you a higher rate of interest.

How are people reacting to this rate hike?

The market has crashed by over 300 points in response to this rate hike. The banking sector has bore the brunt of this hike. If you are curious and ask me why, the answer is:

1. Since the rates on deposits are hiked, the profits earned by banks might be affected
2. Even though the rates on loans are hiked, which might increase the banks revenue, the point to note is that, not all loan customers may be able to afford the hiked rate of interest. There may be many loan defaults and in turn losses to banks

As an investor, a company’s profit is the main criteria to buy/sell its shares. Since the above two points mean that, the profits of banks may be affected, investors have started selling bank stocks and in turn their shares are down heavily…

Some statistics:

1. ICICI Bank – down Rs. 32 or 2.8% from the days open price
2. HDFC Bank – down Rs. 52 or 2.3% from the days open price
3. State Bank of India – down Rs. 110 or 4% from the days open price
4. Bank of Baroda – down Rs. 26 or 2.9% from the days open price
5. Punjab National Bank – down Rs. 52 or 5% from the days open price
6. Axis Bank – down Rs. 46 or 3.6% from the days open price

As you can see, the country’s 6 major banks have lost anywhere between 2 to 5% of their share price in a single day because of this announcement

Will Inflation be curbed because of this rate hike?

The honest answer would be – let us wait & watch and hope for the best. Usually rate hikes help curb inflation and that is what the RBI has tried here. How effectively it would help curb inflation is something that time would have to tell.

Is 4% too much?

Some market experts have a feeling that 4% rate of interest on the savings account deposits is too much. Even though it might be good news for savings account holders, the question here is, whether this is too much or not.

During my career, I have worked in the United States and am currently working in Singapore. The rate of interest on savings accounts here is less than 0.5%. The rate of interest on fixed deposits itself is less than 4%. This has both pros and cons. Though my bank deposits are going to earn me a miserable rate of interest, I don’t pay exorbitant rate of interest on my loans.

A simple comparison:

The EMI on a home loan in India is approximately Rs. 1000/- for a loan of 1 lakh


The EMI on a home loan in Singapore is approximately S$400/- for a loan of S$100,000. This is for a foreigner like me. A local citizen of Singapore would get a loan at a even lesser rate.

Let me not divert too much away from the topic.

If you ask me, yes 4% is a bit too much. Where does this 4% come from? The interest other loan customers pay the bank. So, by making loan customers (again you and me) pay more for loans, the banks are offering a higher rate of interest on deposits. Which in turn is making loans costlier and more difficult to pay for the common man.

So definitely this 4% is a bit too much only.

But as always, there isn’t a thing either you or me can do about this. So the best thing for us is to, avoid taking loans and enjoy the higher rate of interest on our savings accounts.

Happy Saving folks!!!


  1. As I undderstand that hike in interest rate help in curbing the inflation rate but I m surprised & amazed that RBI is having only this tool. Even so much hike inflaton rate doesnot seems to come down.So how far RBI will go in raising the interest rate will be interesting to watch.How GDP growth can be sacrificed for controlling inflation rate is a big question

  2. Even as many indicators point to moderating growth, both headline and non-food manufactured products inflation were at uncomfortably high levels according to RBI, so they can't control the hike as well.


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