RBI rate hike may halt rally in BFSI sector, pressure on bank NIMs seen

Broader markets, especially automobile stocks, may also react negatively going ahead

In its last monetary policy of the calendar year, the Reserve Bank of India (RBI) opted to hike policy rates by 35 basis points (bps) and affirmed monetary tightening would continue.
 

The market reaction was marginal, with the Nifty50 Index down 0.44 per cent and the Bank Nifty down 0.1 per cent. The optimists had expected the RBI to hit the pause button after the US Federal Reserve signalled it was softening its hawkish stance. 
 

India’s central bank has hiked the repo rate by 225 bps since May. The consensus expectation is another 0.25 per cent (or 25 bps) hike in the next policy review in February 2023.
 

The RBI’s apparent concern on inflation remains, as core inflation (stripped of food and fuel) is high at 6 per cent (October 2022). Concern about growth is not very serious, as of now. The real policy rate is hovering over a slight negative. 
 

The RBI reduced the gross domestic product (GDP) growth forecast to 6.8 per cent for 2022-23 (FY23), from the earlier 7 per cent, and to 7.1 per cent for the first quarter (Q1) of 2023-24 (FY24), from 7.2 per cent.
 

The Consumer Price Index (CPI) is projected to remain above 4 per cent through calendar year 2023. The CPI estimate is unchanged at 6.7 per cent for FY23 and at 5 per cent for Q1FY24 and 5.4 per cent for the second quarter (Q2) of FY23. This assumes an average price of $100 per barrel for the Indian crude basket. In the second half (H2) of FY24, inflation is expected to moderate to below 5 per cent if the monsoon is normal. 

 

The RBI is worried about global slowdown and trade volatility. The GDP growth rate is estimated to have grown at 6.3 per cent in Q2FY23 after an increase of 13.5 per cent in Q1 when the base effect from the second wave of the pandemic (April-June 2021) was perceptible. Economic activity is encouraging in the third quarter, but H2FY23 will see growth rates easing. 
 

Demand is still supported by pent-up spending and discretionary festival spending as unlocking persists. But this is not evenly distributed, with rural demand lagging behind.
 

Merchandise exports contracted in October after expanding for 19 consecutive months. Growth in non-oil, non-gold imports decelerated. Liquidity remains a surplus. Hence, a further tightening is indicated. Geopolitical tensions continue, leading to uncertainty about food and energy prices and potentially, supply chains. However, the slowdown has led to corrections in metals and other industrial input prices. Nevertheless, wholesale price inflation is well above CPI at 10.7 per cent, so manufacturers will try to pass on higher input costs they have been forced to absorb. 
 

The expectation of further rate hikes is a dampener on growth expectations. It’s likely that as the credit/deposit ratio rises, banks will offer higher deposit rates, further putting pressure on net interest margin.
 

The question mark is on consumption.
 

Will higher interest rates and tighter money make consumers tighten their belts?
 

The RBI has to walk a tightrope in this regard.  The Bank Nifty is coming off record highs, but has gained 3.4 per cent in the last month and 20.6 per cent in the past 12 months. The Financial Services Index is up 2.35 per cent month-on-month (MoM) and 9 per cent year-on-year (YoY), while the PSU Bank Index is up a whopping 14.3 per cent MoM and 62.5 per cent YoY and it went up regardless of the policy.
 

 The banking, financial services and insurance sector is the most rate-sensitive and the monetary policy committee may have called a halt to the rally. The broader market could also react, especially sectors like automotive, which are both capital-intensive (in manufacturing) and rate-sensitive in terms of demand.