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RBI Surprises the Market with the Rate Hike

On Wednesday, RBI surprised the market with an unscheduled policy announcement in the form of a Rate Hike. RBI increased the Repo Rate by 40 basis points to 4.4% and also increased Cash Reserve Ratio (CRR) by 50 basis points to 4.5%. This is the first-rate hike since August 2018. When we take into account RBI’s decision in April’s Policy regarding Standing Deposit Facility, the effective rate hike is 80 basis points. By increasing CRR, RBI will suck the liquidity to the tune of around Rs 87,000 crore from the market. This CRR rate hike is applicable from May 21.

The market was expecting a rate hike in June's RBI policy meeting and most of the participants were expecting a rate hike of around 20 to 25 basis points. There was also a view that RBI was behind the inflation curve and it ought to have increased the rate before a few months. With this announcement, RBI has surprised the market not only by the timing of the hike but also by the quantum of the hike. It appears that RBI intends to take Repo Rate to a pre-covid level which was around 5%, if this is the case it won’t be a surprise if RBI gives another hike in its next policy meeting which is scheduled in the next month.

This rate hike comes at a time of rising inflation and it was expected to happen sooner or later. Inflation pressure is coming from everywhere, food prices and fuel prices have been increasing steadily thereby pushing inflation to a very high level. So the RBI had to act and try to tame the inflation. Further, factors like expected rate hikes in the US and other developed markets, the continuance of war between Russia and Ukraine, expected supply chain disruptions due to rising covid cases in China, and an increase in global food and fuel prices have also forced RBI to act in this manner.

This rate hike will affect rate-sensitive sectors like Banking, NBFC, Real Estate and Automobiles. This also starts the end of all time low-Interest Rates and will also affect the profitability of certain rate-sensitive sectors.  The equity market did not take this surprise positively and Sensex crashed by more than 1,000 points. Similarly, the 10-year bond yield also rose to a level above 7.39% indicating an upcoming rise in the cost of funds