Money just got costlier

Reverse repo rate hiked 25 bps; India Inc says expansion plans may take a knock.

The cost of money for India Inc as well as the retail consumer is set to go up by a quarter to half a percentage point, with the Reserve Bank of India raising the key short-term reverse repo rate by 25 basis points today.

The reverse repo rate has now moved up to a four-year high of 6 per cent. Presenting the quarterly review of monetary policy, RBI Governor YV Reddy said the "modest pre-emptive action" had been taken to marry growth with stability.

Reddy has left GDP growth forecast unchanged at 7.5-8 per cent for 2006-07 and inflation rate projection at 5-5.5 per cent.

This is the sixth 25 basis point hike since the rate hardening cycle began in October 2004 and the third hike since the beginning of 2006. However, the cycle of rising rates seems not to be over yet.

"On balance, a modest pre-emptive action in monetary policy is appropriate at this juncture while being ready to respond flexibly and promptly by closely monitoring the related developments," Reddy said.

Bankers maintain that the RBI may keep the rates unchanged at its mid-term review on October 31 but may hike them again in January 2007.

It is a matter of time before banks across the board hike their lending rates. The asset-liability committees of almost all banks will meet over the next few days to take a call on the quantum of hike "" between quarter and half percentage points.

However, the bond market gave a thumbs up to the RBI decision as it lifted the uncertainty surrounding the market. The benchmark 10-year gilt yield rose marginally to 8.28 per cent after the rate hike but closed the day at 8.22 per cent against yesterday's closing of 8.21 per cent.

"The market has already priced in the hike," said Nitin Jain, head of fixed income securities at I-Sec, a primary dealer.

Bank stocks cheered the RBI move. The BSE banking index "" Bankex "" was the largest gainer among the sectoral indices today, rising 4 per cent against the 2 per cent rise in the Sensex.

The Bankex was up by 181 points to close at 4,569.30 today even as the Sensex rose 200 points to close at 10,415. However, the primary reason behind the rise was the RBI's weekend decision to allow banks to raise hybrid capital overseas, analysts said.

Housing Development Finance Corporation (HDFC) Chairman Deepak Parekh said the largest mortgage company in the country might hike its home loan rate now by at least a quarter percentage point.

ICICI Bank, however, would wait a while before raising rates as any rate hike could impact consumer demand, said its retail banking head K Vaidyanathan. It has already hiked its home loan rate thrice in 2006. Its floating rate loans are available at 9.5 per cent while fixed loans cost 10.75 per cent. LIC Housing Finance, too, is bracing for a rate hike.

"We have little choice other than hiking home loan rates," its CEO S K Mitter said.

India Inc is not happy with the rate hike as it will impact corporate expansion plans. A cross-section of senior executives in different sectors said this would slow investment programmes.

Siddhartha Roy, economic advisor with the Tata Group, said it would raise the cost of capital and thereby adversely impact margins of the corporate sector, especially small and mid-size companies. This, in turn, would adversely affect the ability of the companies to invest.

According to him, new projects would be worst hit by the rate hike. "Companies can't stop implementation of a project half-way because of the rate hike. But they will think twice before kicking off new projects," he pointed out.