rbi: Fed's uncommon 75 may push RBI to go for steep hikes

The US Federal Reserve‘s larger-than-expected 75 basis point interest rate hike on Wednesday will likely push the Reserve Bank of India (RBI) to step up its tightening cycle to maintain the differential between the two countries, traders and bankers said.

The resultant impact on local bond yields could lead to the benchmark 10-year paper rising beyond 8% for the first time since October 2018, they said. One basis point is 0.01 percentage point.

The US Federal Reserve’s increase in the policy rate was the single sharpest hike in 28 years, taking the central rate to 1.625% (official range of 1.5-1.75%). More importantly, it has guided for at least another 50 basis point hike at its next meeting on July 27.

Bankers said the Fed action has limited RBI’s options as it looks to maintain the rate differential while setting about its primary task of controlling inflation. The 10-year bond yield ended at 7.62% on Thursday.

‘Gradual Rise in Yields Likely’

“In all probability, we will see another US hike before the RBI meets again in August, which means that Indian rates will also have to adjust approximately by at least a similar quantum,” said Naveen Singh, head fixed income at

Primary Dealership. “We could hence see the repo rate increase to a peak of 6.50% in December from 4.90% now.” The RBI raised the key policy interest rate by half a percentage point to 4.9% on June 8. The next policy review is set for August 2-4. Bankers said increments of 25 basis points each will not work now and the RBI will have to go for a higher 50 basis point move to have any effect on prices. What that means is the yield on the benchmark bond is set to increase, possibly impacting government borrowing, they said.

“Though there is no direct correlation between the US and Indian rates, it is fair to assume some impact in India,” said Bhaskar Panda, head, overseas business,

.

“Yields are likely to go up, though it will be gradual as the RBI also has to manage government borrowing. Real rates in India have been negative for a long time and they will have to adjust to neutral or positive territory.”

The government gross borrowing target for FY23 is at a record Rs 14.31 lakh crore, up from Rs 12.05 lakh crore the previous year. Out of this, Rs 8.45 lakh crore is likely to be borrowed in the first half of the fiscal year. Government spending is seen as one of the key drivers of the Indian economy’s revival.

The RBI will likely delay the rise in yields through primary and secondary market buybacks.

“Yields have to go up, there are no two ways about it,” said Singh of ICICI Securities PD. “But the rise could be gradual as traders price in a higher number with every auction. Ultimately, if the repo rate goes up to 6.50%, the benchmark yield has to follow.”

Within hours of the Fed action, the central banks of Switzerland and Hungary raised interest rates, vowing to fight inflation and protect their currencies from falling sharply. The hike by the Swiss National Bank was the first in 15 years, indicating the change in global outlook as inflation control takes precedence over growth.

Bankers said the RBI’s situation is similar to its western peers and even a record government borrowing will not sway its focus. “No central bank has a clue on where inflation is headed. Yes, the borrowing costs for the government will go up but before the 2024 elections, the government would rather take the bitter pill of higher costs than risk runaway inflation,” said a senior private sector banker.

The RBI has already hiked its benchmark repo rate by 90 basis points this fiscal year. Bankers said food and fuel remain pain points for India. In the absence of any change in the global outlook and with the government unlikely to tighten spending, the RBI has no choice but to lead the fight against inflation, they said.