Would the surprise rate hike by RBI impact the mid-market debt?
On May 4, RBI announced 40 basis points (bps) hike in repo rate (the rate at which RBI lends short-term funds to commercial banks) to 4.4% effective immediately and a 50bps rise in cash reserve ratio (the share of bank deposits held as reserves with RBI) to 4.5%. Both the quantum of hike and timing was surprising for the markets as the central bank was expected to hike rates in June.
RBI has kept the reverse repo rate (the rate at which RBI borrows funds from commercial banks) unchanged and retained the monetary policy stance as ‘accommodative’ while focusing on ‘withdrawal of accommodation’.
Inflation fear
The surprise hike followed RBI’s shift in focus towards controlling inflation at the April meeting due to global supply bottlenecks and a surge in commodity prices, especially crude oil at US$100+ levels, following geo-political tensions. Food inflation is a major concern due to shortages of key items like wheat and edible oil in international markets. The pressure on food prices expects to intensify further due to higher feed costs and fertilizer prices. Globally, food prices rose 33% year-on-year in Apr 2022.
Although broadly in line with market expectations, the US Fed announced a 50bps hike (biggest since 2000) in interest rates to the range of 0.75% to 1% and launched the “Quantitative Tightening” program a day after RBI action. While raising rates, the US Fed mentioned combating inflation will remain its major focus as the continued pricing pressure due to demand- and supply-side factors were exacerbated by new crises like the Russia-Ukraine conflict and lockdowns in China.
The European Central Bank is also expected to end its near-decade-long quantitative easing policy due to the rise in inflation to roughly four times its 2% target.
Market reaction
India’s bond market spooked post the surprise hike. The benchmark 10yr g-sec yield rose to its 3-year high at ~7.4% after the rate hike. The anticipated draining of liquidity of INR 87,000 crores by RBI due to a hike in CRR and expectations of forthcoming rate hikes expect to keep the bond yields elevated.
Corporate bond yields across the rating categories have been affected too as depicted in the chart below.
Would the mid-market debt be impacted?
Assuming a quick and equivalent transmission of repo rate, the mid-market enterprises that are heavily reliant on the loan market expect to be impacted due to the rise in banks' External Benchmark-Linked Lending Rate?(EBLR). Also, the immediate linkage of mid-market debt to bond yields has been found to be stronger with respect to the hike.?
However, if we consider the non-financial services sector, the overall impact expects to be less significant due to the lower leverage of the corporates on average compared to the previous rising rate environment. When it comes to NBFCs, the overall impact on Net interest margin (NIM) could be limited as the pricing of loans is also expected to increase.?Further, if the proposed RBI framework to remove the interest rate ceiling for NBFC-MFIs is implemented, all segments of retail credits are expected to be less impacted.
What about economic growth?
The Indian economy expects to continue its journey on the recovery path due to normalcy in activities post the third wave of Covid, resurgence of private consumption and discretionary spending, and the forecast of a normal monsoon supporting rural demand.?
The Federal Open Market Committee chair in the US has also emphasized that ‘growth will remain solid in 2022’ and expects private sector balance sheets to be strong enough to bear the impact of a tightening monetary policy.
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