FD rates to get more attractive? RBI’s 35 bps rate hike makes a case

However, this time, the transition of 35 basis points repo rate hike to FD rates is expected to be on a slower pace. Nevertheless, banks and other financial services providers are likely to enter into an interest rate-war once again for offering alluring FDs.

RBI governor Shaktikanta Das in the policy meeting said, “the pace of transmission of monetary policy actions to lending and deposit rates has quickened in the current tightening phase, beginning May 2022.”

With the latest hike, the policy repo rate has climbed to a whopping 225 basis points so far in FY23. Now, the repo rate is at 6.25%, the highest level since August 2018.

It all began when Russia invaded Ukraine which led to a series of global economic crises such as supply-chain disruption, energy crises, soaring crude oil prices, dollar strengthening, and one of them also being severe inflationary pressure among others. This pushed major central banks to take an aggressive approach in their monetary policy outcomes, all done for the sake of tackling multi-year high inflation, and RBI was no different.

For FY23, RBI’s first rate hike was 40 bps in May, followed by three consecutive rate hikes to the tune of 50 bps each between June to October, and then some softening to 35 bps in December policy. 

On the other hand, the weighted average domestic term deposit rate on fresh and outstanding deposits increased by 150 bps and 46 bps, respectively, between May to October, as per RBI.

So why December saw a smaller rate hike and how will it make FDs more attractive ahead?

The reason behind the smaller size rate hike in the December policy is the cooling down in CPI inflation below 7% in October. However, although RBI has hiked the repo rate at a smaller quantum, they have continued to hole withdrawal of accommodation stance to ensure inflation remains within the target going forward while supporting growth.

Hence, both lending rates and deposit rates are expected to rise ahead!

Prasenjit Basu – Chief Economist, ICICI Securities said, “The RBI raised its policy repo rate by 35bp to 6.25% as expected, with a 5-1 vote. It also persisted with a policy stance of “withdrawal of accommodation”, but based on only a 4-2 vote. We do not view this as evidence of any intent to further tighten policy in subsequent MPC meetings, but merely as an acknowledgment of the persistence of excess liquidity currently—which the RBI will drain daily, as it has for the past 9 months.”

Basu added, “The smaller rate hike will be passed through to depositors and borrowers quite quickly this week. But the good news (in our view) is that further rate hikes are unlikely. Fuel inflation will ease unless there are unexpected surprises from the west-imposed cap on Russian seaborne oil exports, and the good Kharif harvest should allow food inflation to moderate as well.”

Explaining more in detail, Anil Rego, founder, and fund manager at Right Horizons, SEBI Registered Portfolio Management Service provider said, the financial sector has historically been among the most sensitive to changes in interest rates.

Typically, during a rising interest rate scenario, the banking sector passes on rate hikes through the floating rate loans while delaying the rate hikes for deposits, benefitting from spreads, and expanding margins, Rego added.

Further, Rego said, “Banks report strong topline growth due to healthy disbursements, higher loan rates, and robust earnings growth on the back of promising advances. A change in stance to dovish going forward by RBI will lead to a rally in the banking segment while a prolonged hawkish stance will impact deposit rates and lead to narrowing NIMs, more so for PSBs.”

But Ajit Kabi, Banking analyst at LKP Securities believes the banks may witness an uptick in yields as loan repricing will be sooner than repricing of deposits. Moreover, increasing share in Floating rate loans is likely to keep the NIMs intact.

For fixed income investors, Vivek Goel, Joint Managing Director, Tailwind Financial Services said, “the yields have become more attractive and we suggest remaining on the shorter end of the yield curve as the shape of the curve is largely flat and there is limited term premium in the current environment, while risks continue to be evenly balanced.”

While Anand Varadarajan the Director, of Asit C. Mehta Financial Services believes from an investor perspective, fixed-income investors would benefit from high-interest rates from FDs, debentures, bonds, etc. While equity investors will need to realign their investments from rate-sensitive sectors like auto, consumer discretionary, etc.

By how much banks pass on the benefit of the December policy rate hike on their FDs will be keenly watched. However, on the repo rate hike transition in deposit rates, the RBI governor said, the central bank is keeping a close watch on this process of transmission.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint.