The Reserve Bank of India (RBI) predicts that it will raise the interest rate by 50 basis points in its next two policy meetings, bringing the rate to 6.0 percent. This prediction is based on a report from the research institute Kotak Institutional Equities.
Interest Rate Hike and Change in Monetary Policy
The interest rate hike follows the central bank's decision to increase the repo rate by 25 basis points to 5.5 percent on Wednesday. This decision also indicates a shift in the monetary stance from neutral to a tightened adjustment. The report mentioned increasing inflationary pressures and emphasized the necessity for further rate hikes, even if the monetary tightening cycle is relatively shallow.
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The report states: "This action is taken due to the improved macroeconomic outlook and rising inflation forecasts. This strengthens the argument for further rate hikes, despite the likelihood of a relatively shallow tightening cycle."
Financial Conditions and Credit Risks
The report addresses concerns regarding credit health that typically accompany rising borrowing costs and emphasizes that the financial sector enters this upward phase with strong fundamentals. While higher rates usually provoke caution regarding asset quality and growth, the current conditions present limited risk due to clean balance sheets and stricter regulations imposed after regulatory scrutiny on unsecured lending during the 2023-24 fiscal year.
The report also notes that recent credit demand has been primarily driven by corporate borrowers whose balance sheets appear stronger compared to previous rate periods. Although there is a possibility of reduced loan growth, Kotak Institutional Equities attributes this mainly to the normalization of short-term financial needs that had risen after the Middle East crisis, rather than solely to rate pressures.
Regarding profitability, the institute believes that large private lenders are in the best position to benefit from the upward movement of rates through the expansion of interest margin. "A structural change in balance sheets, with borrowing rates increasingly supported by fixed-rate deposits, should lead to an expansion of profit margins for banks, especially large private banks, even if the anticipated rate cycle is relatively shallow," the report adds.
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