RBI hikes rates, tightens lending norms:: Goldman Sachs

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The Reserve Bank of India hikes rates, tightens
lending norms


The Reserve Bank of India (RBI) hiked the repo rate by 25 bp and reverse repo rate by 25
bp, in line with the consensus and our expectations. After today’s decision, the reverse repo
rate moves up to 5.25% and the repo rate to 6.25%. The cash reserve ratio (CRR) remains at
6.00%. The effective short-term policy rate has risen by 300 bp in 2010 thus far, in line with our
expectations, with 150 bp in repo rate increases, and another 150 bp by moving from the reverse
repo to the repo rate. The rate hike, in our view, will slowly start transmitting into overall bank
rates.



The measures introduced to tighten lending standards are more in the nature of a warning
to real estate companies. First, the RBI lifted the standard provisioning for teaser home loan
rates to 2% from 1%. Second, it put limits on the loan-to-value ratio on home loans to 80%. Third,
it lifted risk weights on loans of Rs7.5 million or above to 125% from 50%-75%. We think that
these measures are more in the nature of a warning at this stage to real estate companies to not
raise property prices aggressively and reduce structured lending. Most loans are under Rs7.5
million, and the loan-to-value cap given is still relatively high.
Although the RBI kept its inflation target unchanged, the commentary was relatively
hawkish, with a number of risks discussed. Even though the RBI mentioned that ‘the likelihood
of further rate actions in the immediate future is relatively low’, it said that future inflation risks
are on the upside. The RBI discussed the threat from rising asset prices, higher commodity prices,
a large current account deficit, inflation expectations at elevated levels, and significant risks of
structural food inflation spilling over to other commodities. It also mentioned that domestic
capacity utilization is slowly approaching its pre-crisis peak in many industries.
Significantly, the RBI did not explicitly mention the exchange rate in its policy statement.
This suggests to us that its general hands-off policy on the INR may continue, and would likely
change only if there was significant volatility. We continue to maintain our USD/INR forecasts of
44, 43.4, and 43 on 3, 6 and 12-month horizons respectively, though risks are to further
appreciation of the INR if capital inflows were to increase following quantitative easing by the
Fed.
We think that given the hawkish commentary and the macroeconomic outlook, the pause in
the rate hiking cycle may be short and the RBI may resume rate hikes in early-2011. We
applaud the RBI for being ahead of the curve in attempting to contain nascent bubbles in property
prices and the proliferation of structured lending schemes. The policy statement clearly suggests
that the RBI will pause for the time being, i.e., in the December mid-quarter policy review. We
continue to hold the view that after the pause in December, the RBI will hike policy rates by
another 50-75 bp by end-June 2011 (see India: Raising our GDP, inflation, and interest rate
forecasts, Asia Economics Flash, October 1, 2010) due to high current and fiscal deficits, still
loose financial conditions, rising asset prices, and inflation above the RBI’s target range.